India Data Bank 2000-2008

COUNTRY REPORT ON INDIA: ECONOMIC PERFORMANCE IN 2002-2004 AND OUTLOOK FOR 2005-2007 For THE ECONOMIC AND SOCIAL SURVEY OF ASIA AND THE PACIFIC 2005 ______________________________________________________________________

Dr. Tarun Das* Economic Adviser Ministry of Finance Government of India New Delhi-110001.

10 November 2004 ______________________________________________________________________ * The paper expresses personal views of the author and should not be attributed to the views of the Ministry of Finance or the Government of India. Author would like to express his gratitude to the Poverty and Development Division, ESCAP, United Nations, Bangkok for providing an opportunity to prepare this paper, and the Ministry of Finance, Government of India for granting him necessary permission for accepting this work.

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CONTENTS

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PAGES

ACRONYMS

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A Macroeconomic Performance, Issues and Policies

5-15

1. Overview 2.

(a) (b) (c) (d) (e)

5

Growth performance Overall GDP outcome in 2001-2002 and outlook for 2003-2005 Determinants of GDP performance by major sectors Determinants of GDP performance by major industries Demand factors- Savings and investment Employment and unemployment situation

3. Inflation (a) Movements in WPI and CPI (b)Price movements of major categories (c) Determinants of inflation (d)Inflation outlook

7 7 8 11 12 13 15-18 15 16 16 18

4. (a) (b) (c) (d) (e)

Trade and Exchange Rates Exports and imports in 2001 and 2002 Composition of trade Direction of trade Trade policies and performance Exchange rate policies

18-23 18 19 20 22 23

5. (a) (b) (c) (d) (e)

Capital inflows and outflows Balance of payments Foreign investment Foreign exchange reserves External debt and debt service Outlook for external sector for 2003-2005

24-27 24 24 25 26 27

6. Fiscal developments (a) Overall fiscal situation in 2001 and 2002 (b) Fiscal deficit and financing (c) Contingent liabilities (d) Public debt 7. Money and Finance (a) Monetary policies (b) Financial sector performance and policies

28-34 28 30 32 33 34-36 34 36

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8. Key policy issues and responses (a) Development policies (b) Fiscal policies (c) Unfinished agenda of reforms

37-39 37 37 38

Statistical Tables: Table-1: Selected Economic Indicators

40-42 40-42

Part-B: Dynamics of population ageing: how India can respond?

43-59

1. 2. 3. 4. 5. 6.

Introduction Social security system in India Pension reforms in India Social health insurance in India Caring for the elderly people Migration

43 43 45 47 50 51

Statistical Tables: Table-2: Trend of major macro-economic indicators 1999-2007

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52-59 52-59

ACRONYMS ADB Asian Development Bank BOP Balance of Payments CPI Consumer Price Index CRR Cash Reserve Ratio ECB External Commercial Borrowing EHTP Electronic Hardware Technology Park EOU Export Oriented Unit EPCG Export Promotion Capital Goods EPZ Export Processing Zone EXIM Export Import Policy FCCB Foreign Currency Convertible Bond FDI Foreign Direct Investment FERA Foreign Exchange Regulation Act FIIs Foreign Institutional Investors FTZ Free Trade Zone GDP Gross Domestic Product GDR Global Depository Receipt ICOR Incremental Capital-Output Ratio IDA Industrial Disputes Act IDBI Industrial Development Bank of India IFCI Industrial Finance Corporation of India MIGA Multilateral Investment Guarantee Agency MODVAT Modified Value Added Tax NEER Nominal Effective Exchange Rate NPA Non performing assets NRI Non-Resident Indian OCB Overseas Corporate Body OGL Open general license PIO Person of Indian Origin POL Petroleum, Oil and Lubricants PPP Purchasing Power Parity RBI Reserve Bank of India REER Real Effective Exchange Rate SEBI Securities and Exchange Board of India SEZ Special Economic Zone SIL Special import license SLR Statutory Liquidity Ratio SSI Small Scale Industry UTI Unit Trust of India WPI Wholesale Price Index

NOTES: 1. 2. 3.

Years mentioned in the Report refer to fiscal years starting with April and ending with March of the next calendar year. Thus the year 2004 implies April 2004 to March 2005. Currency unit Dollar ($) in the Report refers to US dollar, unless mentioned otherwise. The following numerical units are used in the report: Thousand = 1000 Lakh = 100 Thousand Million = 1000 Thousand = 10 Lakh Crore = 10 Million = 100 Lakh Billion = 1000 Million = 100 Crore Trillion = 1000 Billion = 100000 Crore

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COUNTRY REPORT ON INDIA: ECONOMIC PERFORMANCE IN 2002-2004 AND OUTLOOK FOR 2005-2007 DR. TARUN DAS, Economic Adviser, Ministry of Finance, India. Part-I: Recent Economic and Social Developments A. Macroeconomic Performance, Issues and Policies 1 Overview The economy experienced a significant recovery in GDP growth rate from 4 per cent in 2003 to 8.1 per cent in 2003 mainly driven by the rebound of agriculture with a growth rate of 8.1 per cent aided by a bumper food grains production. Industry sustained its growth at 6.5 per cent, while services growth improved to 8.4 per cent in 2003. The high growth could not be sustained in 2004 due to both internal and external shocks. Internal factors included monsoon failures and infrastructure constraints, while external factors included hardening of international prices of oil, metals and minerals induced by global economic recovery and rising demand in USA, EU and China. The average annual rate of inflation in terms of the Wholesale Price Index (WPI) increased significantly from 5.4 per cent in 2003 to 6.8 per cent in 2004 mainly driver by higher prices of minerals, petroleum products, metals, metal products, particularly iron and steel. Average inflation based on the Consumer Price Index (CPI) also increased from 3.9 per cent in 2003 to 5 per cent in 2004 reflecting higher prices of food items which account for 57 per cent weights in the CPI. India’s external position remained comfortable in 2004, notwithstanding the pick-up of imports by 21 per cent. Merchandised exports recorded an excellent increase by 20 per cent and net invisibles by 18 per cent. The current account recorded a surplus amounting to 1.3 per cent of GDP in 2004, almost the same as 1.4 per cent of GDP recorded in 2003. Transfers from Indians working abroad continued to remain buoyant. On the capital account, direct foreign investment showed some improvement, while portfolio investment flows declined significantly from $11.4 billion in 2003 to only $1 billion in 2004 reflecting bearish stock markets and change in disinvestment policies of the government due to ideological influence of the left parties on the new coalition government. Commercial borrowings by the corporates picked up due to lower interest rates in international markets. The combined result was an increase of foreign exchange reserves by US$20 billion in 2004 on top of an increase by $31 billion in 2003. The total foreign exchange reserves (including gold and SDR) stand at more than US$122 billion equivalent to 15 months of imports and 25 times the short-term external debt.

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Central Government faced fiscal strain in 2004 due to revenue shortfalls caused by delayed budget and lower realisation of government disinvestment in public enterprises. While nominal spending was kept within the budgeted amounts, there were expenditure overruns on subsidies. The gross fiscal deficit of the Central government declined from 4.7 per cent of GDP in 2003 to 4.3 per cent of GDP (due to higher growth of nominal GDP caused by high inflation). The fiscal situation of the State governments also remained under pressure due to rising current expenditure and constraints on resource mobilization. The combined gross fiscal deficit of the States increased from 4.1 per cent of GDP in 2002 to 5 per cent of GDP in 2003 and is budgeted at 3.5 per cent of GDP. As a result of fiscal incentives provided by the Centre to the states for conditional fiscal reforms to reduce state deficits, the consolidated deficit of the Central and State governments remained around 9.5 per cent of GDP in both 2002 and 2003 and is expected to decline to 7.9 per cent of GDP in 2004. Outstanding debt (including both domestic and external debt) of the general government, excluding guarantees and other contingent liabilities, is likely to reach 95 per cent of GDP (comprising outstanding Central government debt at 66 per cent and State government debt at 29 per cent) at the end of March 2005. Including the public sector enterprises, the consolidated public sector deficit is estimated to have exceeded 11.5 per cent of GDP and public sector debt over 100 per cent of GDP. The budget for 2004-05 aimed at reducing the central government fiscal deficit to 4.4 per cent of GDP from 4.8 per cent in 2003, with revenue deficit targeted at 2.5 per cent and primary deficit targeted at 0.3 per cent of GDP. On the revenue side, key initiatives included introduction of a new tax system for textiles, increase of service tax from 8 to 10 per cent and widening its scope, introduction of 2 per cent education cess on all taxes, no income tax for assesses having income up to Rupees one lakh, introduction of the Value Added Tax at the state levels from April 1, 2005, replacement of long term capital gains tax by transactions tax, reduction of peak customs duty from 25 to 20 per cent, reductions of customs duties on steel, minerals, meat and fish, and exemption of customs duties on t ractors and agricultural implements and aids for physically handicapped persons. On the expenditure side, the main initiatives included passing of a Fiscal responsibility and Budget Management Act by the Parliament, prepayment of high cost external debt, buy back of bank’s holding of central government debt, a debt swap scheme for the states, reduction of interest rates for public provident fund and small savings and expansion of the scope of conditional fiscal and structural reforms by the states. Reforms in agriculture and industry continued with introducing farm income insurance scheme, removal of restrictions on exports of food grains, encouraging agri-business, and de-reservation of more items from the reservation list of the Small Scale Industries (SSI). In the area of infrastructure, progress was achieved in road construction and metro rail and public-private partnership was extended for development of seaports and airports.

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In the financial sector, regulations were tightened particularly for non-banking financial corporations (NBFCs), foreign entry to the banking system was further liberalized, and limits were raised on overseas investment by Indian companies. Share market was volatile in 2004 reflecting development in political economy, erratic monsoon and high inflation at home and hardening of international prices of crude oil, metals and minerals. After falling in the first quarter of 2004, the stock market staged a rally since the second quarter, reflecting political stability and continuity of economic reforms. International credit rating agencies upgraded Indian scrips and maintained positive outlooks on the basis of significant build up of foreign exchange reserves along with containment of fiscal deficit. For providing adequate liquidity to meet credit growth and support investment demand with price stability, the RBI continued with its policy of active liquidity management with additional tool of Market Stabilisation Scheme. The cash reserve ratio and the repo rate (overnight lending rate) were increased to tackle rising prices. The exchange rate of rupee against the US dollar had a tendency to appreciate in 2004 due to weakening dollar against major currencies, but ended with a marginal depreciation due to acceleration of imports. The RBI took advantage of the favorable balance of payments to accumulate reserves through partially sterilized intervention. Despite significant reduction of the RBI bank rate in recent years, lending rates of the banks did not fall commensurately. Bank lending and deposit rates fell by only 50-150 basis points in 2003-2004. The prime lending rate (PLR) virtually remained unchanged, reflecting high transactions cost of banking operations and the rigidities in administered rates on small savings. Banks continued to provide credits to profitable corporates at below PLR and reduced the maximum spread over PLR and so the effective lending rates declined by 50-100 basis points. Sanctions and disbursements of the long-term credit by the financial institutions accelerated in 2004 due to rise in investment demand. Lendings by commercial banks, which generally consist of working capital and trade finances, also recorded significant growth due to acceleration of both food and non-food credits. 1. Growth Performance (a) Overall GDP outcome in 2003-2004 and Outlook for 2005-2007 Overall GDP growth rate decelerated from 8.1 per cent in 2003 to 6 per cent in 2004 mainly due to decline in agricultural value added by 2 per cent caused by deficient rainfall (Table-2.1). However, there was improvement in the growth of industry from 6.5 per cent in 2003 to 7.1 per cent in 2004, and of services from 8.4 per cent to 8.8 per cent due to pick up of both consumer and investment demands and acceleration of exports. Assuming that there would be no major internal or external shocks, which might have destabilizing effects on the Indian economy, no monsoon failures and no political instability, India would be able to sustain real GDP growth rates in the range of 7-7.5 per cent in 2005-2007 supported by a growth rate of 2 to 4 per cent in agricultural value added, 7.5 to 8 per cent in industry and 8.5 per cent in services. Industrial production is

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expected to show modest upturn largely driven by cyclical factors and induced by a rise in rural income and increased public spending on physical and social infrastructure. Higher growth would be feasible through a sustained pace of fiscal reforms in both the Centre and States combined with second-generation reforms in labor markets, sectoral levels and local governments. Increased public and private sector savings will boost India’s investment rate and provide necessary resources for upgrading critical areas of infrastructure. While some increased use of foreign capital, particularly of direct foreign investment and portfolio investment, is consistent with external sector viability, the bulk of the savings will be generated domestically. 2.1 Real GDP Growth by Sectors and the Inflation Rate (Per Cent) Items 2002 2003 2004 2005 2006 2007 Actual Actual Estimate Forecast Forecast Forecast Real GDP growth 4.0 8.1 6.0 6.8 7.2 7.5 -5.2 9.1 -2.0 2.0 3.0 4.0 Agriculture 6.4 6.5 7.1 7.3 7.5 8.0 Industry 7.1 8.4 8.8 8.5 8.5 8.5 Services Inflation rate (CPI) 4.0 3.9 5.0 4.0 4.0 4.0 Inflation rate (WPI) 3.5 5.4 6.8 4.0 4.0 4.0 Source: National Accounts Statistics 2004, Central Statistical Organisation (CSO) for 2002-2003 and author’s estimates/ projections for 2004-2007. (b) Determination of GDP performance by major sectors In 2004 agriculture and allied sectors registered negative growth due to erratic monsoon and loss of agricultural crops. However, there was some improvement in the growth rates in secondary and tertiary sectors (Table 2.2). Table 2.2 Growth rates of GDP in selected sectors (in per cent) Sectors 2000 2001 2002 2003 2004Q1 Actual 1. Agriculture & allied sectors -0.1 6.5 -5.2 9.1 3.4 2. Mining & quarrying 2.4 2.2 8.8 4.0 6.1 3. Manufacturing 7.4 3.6 6.2 7.1 8.0 4. Electricity, gas, water 4.3 3.6 3.8 5.4 6.3 5. Construction 6.7 3.1 7.3 6.0 3.6 6. Trade,hotels,transport,commc 6.9 8.7 7.0 10.9 11.0 7.Financial ser. & real estate 3.5 4.5 8.8 6.4 7.0 8. Social and personal services 5.2 5.6 5.8 5.9 9.3 Total GDP 4.4 5.8 4.0 8.1 7.4

2004 Estimate

-2.0 6.0 7.2 6.0 4.0 10.5 7.0 9.0 6.0

Source: National Accounts Statistics 2004, Central Statistical Organisation (CSO) for 20022003 and author’s estimates/ projections for 2004-2007.

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Agriculture and Allied Sectors Prospects of agricultural production in 2004 are not considered to be bright due to erratic rainfall caused by prolonged breaks of monsoon over time and uneven distribution over regions. The seasonal rainfall in 2004 for the country as a whole was 13 per cent below the long period average and 18 per cent area experienced drought conditions. Poor monsoon affected adversely the production of kharif crops (sown in June-July and grown mainly under unirrigated conditions), which account for 55 per cent of the total crop output and 75 per cent of agricultural production. Coarse grains, pulses, oilseeds, cotton and plantation are affected most, while impact is less on the production of rice, wheat and sugarcane where access to irrigation is the greatest. Total foodgrains production is estimated to decline by 4.7 per cent from 212 million tonnes in 2003 to 202 million tonnes in 2004 (Table 2.3). Productions of commercial crops like jute, tea, coffee, oilseeds and sugarcane are also expected to decline, although by lower per centage. However, fruits and vegetables, horticulture and floriculture and allied sectors like fishery, poultry and animal husbandry, which account for 30 per cent production in agriculture and allied sectors, are expected to perform well and achieve a growth rate of 6 per cent. Consequently, overall value added in the primary sector is estimated to decline by 2 per cent in 2004, compared to a growth of 9.1 per cent in 2003. Table 2.3: Agricultural production in 1999-2003 (million tonnes) Crop 1.Total food grains (a+b)

2000 197

2001 213

2002 174

2003 212

2004-Proj 202

(a) Cereals Rice Wheat Coarse grains (b) Pulses 2. Non-food grains (a) Oilseeds (b) Sugarcane (c) Cotton (million bales) (d) Jute / Mesta (mln bales) (e) Tea (million kilogram) (f) Coffee (million kg.) 4. Annual growth rate (%) (a) All crops (b) Food grains (c) Non food grains

186 85 70 31 11

199 93 73 33 13

163 73 65 25 11

197 87 72 38 15

189 84 71 34 13

18 296 10 11 848 301

21 297 10 12 847 301

15 282 9 11 838 275

25 236 14 11 850 275

20 235 14 11 845 270

-6.3 -6.2 -5.7

7.6 8.2 6.1

-15.5 -18.2 -11.2

19.3 22.0 14.5

-3.3 -4.7 -1.0

Source: Min. of Agriculture for the years 2000-2003, and author's estimate for 2004. 9

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The share of agriculture in real GDP declined from around 24 per cent in 2000-2001 to 22 per cent in 2002-2003 and further to 20 per cent in 2004. The enhanced availability of bank credits through priority lending to agriculture and agro-based industries, favorable terms of trade, liberalized domestic and external trade for agricultural products attracted private investment in agriculture in recent years. The Budget for 2004 stepped up public investment significantly for rural roads and rural employment programs. Major measures taken for agriculture development included the following: • • • • • • • • •

Government funding for restructuring Regional Rural Banks. Rural Infrastructure Development Fund revived with corpus of Rs.8000 crore. Priority for Accelerated Irrigation Benefit Program, Launching of National Water Resources Development Project, and Nationwide Water Harvesting Scheme. Launching of National Horticulture Mission. Introduction of National Agricultural Insurance Scheme. Emphasis on agri-business and R&D. Introduction of Food stamps scheme on pilot basis. Tax holiday extended to rural hospitals and agro processing industries

Industry Despite fall of agricultural production, both industry and services performed well in 2004 induced by external demand and investment demand at home. Government announced several monetary and fiscal incentives in the Union Budget for 2004 to boost industrial production and infrastructure development. These policies included simplification and rationalization of both direct and indirect taxes, reduction of peak customs duty to 20 per cent. Latest available information until August 2004 indicate that cumulative industrial growth improved from 5.9 per cent in April-August 2003 to 7.9 per cent in April- August 2004 aided by a growth rate of 5.2 per cent in mining, 8.2 per cent in manufacturing and 7.7 per cent in electricity generation. Given these trends, the year-end industrial growth would be around 7.2 per cent. Consequently, the share of industrial value added in GDP is expected to increase to 27.1 per cent in 2004 from 26.9 per cent in 2003. Service sector The good performance of agriculture and industry in recent years generated demand for transport and communications, trade-related activities and financial services. A rapid increase in expenditure on public administration, social services, rural extension services and defense also had a favorable impact on the growth of service sector. As a result, the share of the service sector in GDP increased continuously from a level of 28 per cent in the early 1950’s to 36 per cent in early 1980’s and further to 52 per cent in 2004. The service sector is expected to grow at 8.8 per cent in 2004 induced by sustained industrial growth, substantial public investment on roads, and sustained growth in financial services and real estate.

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(c) Determination of GDP performance by major industries As per the index of industrial production (IIP), overall industrial growth at 7.9% in AprilAug 2004 is significantly higher than 5.9% achieved in April-Aug 2003 and is aided by a growth of 5.2% in mining (4.1% last year), 8.2% in manufacturing (6.5% last year) and 7.7% in electricity (2.5% last year). As per use-based classification, there is improvement across the board except for consumer non-durables. Capital goods (14.3%), intermediate (8.8%) and consumer durables (13%) performed well indicating rise of investment demand. Among 17 broad manufacturing sub-groups, five subgroups with weights of 30.8% in the IIP achieved growth rates exceeding 8% in April-Aug 2004. These are beverages & tobacco (8.5%), wool, silk & man-made fibre textiles (9.1%), chemicals & products (19.2%), machinery other than transport equipment (27.7%) and miscellaneous manufacturing group (12.4%). Given these trends, the end-year industrial growth in terms of physical production is expected to be 7.2 per cent aided by a growth rate of 7.5 per cent in manufacturing (weight 79.4 per cent), 7per cent in electricity generation (weight 10.4%) and 5.5 per cent in mining and quarrying (weight 10.2%). Table 2.4 Growth of industrial production by broad sectors (per cent) Sectors

Weights (%)

2001

2002

2003

April-Aug 2004 7.9 8.2 5.2 7.7 7.9 4.9 14.3 8.8 8.4 13.0 6.8

2004 Estimate 7.2 7.5 5.5 7.0 7.2 5.0 14.5 8.0 8.5 12.5 6.5

1.Overall industrial growth 100.0 2.7 5.7 6.9 79.4 2.9 6.0 3.2  Manufacturing 10.4 1.2 5.8 5.2  Mining/ quarrying 10.2 3.1 3.2 5.1  Electricity 1. Use-based classification 100.0 2.7 5.7 6.9 35.5 2.6 4.8 5.4  Basic goods 9.7 -3.4 10.5 13.1  Capital goods 26.4 1.5 3.9 6.3  Intermediate goods 28.4 6.0 7.1 7.1  Consumer goods 5.2 11.5 -6.3 11.5 -- Consumer durable 23.2 4.1 12.0 5.7 -- Non-durable goods 3.Overall industrial growth 100 2.7 5.7 6.9 7.9 7.2 • IIP stands for the Index of Industrial Production. Source: Central Statistical Organisation for the years 2001-2003 and author’s estimate for the year 2004.

Six core and infrastructure industries (viz. Electricity, coal, steel, cement, crude oil and petroleum products) having total weight of 26.7 per cent in the Index of Industrial Production (IIP) performed well in 2004 with an average growth rate of 5.7 per cent in the first half of 2004 and is expected to maintain the same growth rate for the full year compared with a growth rate of 5.4 per cent in 2003 (Table 2.5). Other infrastructure sectors such as new mobile telephone connections, goods traffic on railways, cargo handled at both sea ports and air ports, and air passenger traffic at both domestic and international airports also performed well in 2004 due to sustained industrial growth and significant pick up of services activities.

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Table 2.5 Growth rates of major core and infrastructure industries (per cent) Core Industries and Weights 2001 2002 2003 April-Sept 2004 infrastructure in IIP* 2004 Estimate 1. Electricity 10.2 3.1 3.6 4.5 7.8 7.0 2. Coal 3.2 4.2 4.6 3.6 6.6 6.5 3. Steel 5.1 3.6 10.1 6.9 3.0 3.5 4. Crude oil 4.2 -1.2 3.2 1.0 4.2 4.5 5. Petroleum products 2.0 3.7 4.9 8.2 7.4 8.0 6. Cement 2.0 7.4 8.8 6.1 4.8 5.0 Sub-Total 26.7 3.5 5.6 5.4 5.7 5.6 Other infrastructure: 7. Cargo handled at major ports 2.3 9.0 9.9 10.1 9.0 8. Landline phone connections -4.7 -40 2.9 -34.2 -30.0 9. Mobile phone connections 60 119 159 24.6 25.0 10. Revenue traffic on railways 4.0 5.3 7.5 6.3 6.5 11. Civil aviation 4.1 13.3 1.0 8.1 7.5  Export cargo -1.0 18.6 13.8 35.6 35.0  Import cargo -5.0 4.8 6.5 17.4 19.0  International passengers -5.7 9.6 13.1 25.9 27.0  Domestic passengers -13.2 53.5 40 12.3 10.0 12. Upgradation of highways • IIP stands for the Index of Industrial Production. Source: Dept of Programme Implementation for 2001-2003 and author’s estimate for the year 2004.

(d) Demand factors: Savings and Investment The rates of investment and saving in India are high as judged by its level of economic development. Gross domestic savings as per cent of GDP improved from 23.5 per cent in 2001 to 24.2 per cent in 2002 and 25 per cent in 2003-2004 due to reduction of dissaving in the public sector. Gross domestic investment as per centage of GDP improved marginally from 23.1 per cent in 2001 to 23.3 per cent in 2002 and 23.6 per cent in 20032004 due to improvement in both private and public sectors (Table 2.6). India’s private saving rate is comparable to those achieved by the high performing East Asian economies, but its public saving is very low and is a major constraint on domestic resource mobilization. Government is restructuring public expenditures to foster domestic savings, release resources for infrastructure development and to reduce crowding out effect on private investment. Reforms in public sector are under-way to rationalize prices of public goods and services, to increase efficiency of public sector operations and to reduce the capital output ratio. Strengthening legal, institutional and regulatory frameworks in insurance, provident and pension funds, banking, capital markets, petroleum products, power, ports and telecom is also being undertaken to induce private investment in infrastructure. The successive Central government Budgets for 2003-2004 announced various measures for deepening the capital markets and liberalizing further the non-debt creating financial flows. There are signs that both public and private investment have started to revive and the new investment is more efficient and productive. Gross domestic investment as per cent of GDP is expected to improve steadily from 23.7 per cent in 2004 to 27.8 per cent in 2007 13

and gross domestic savings as per cent of GDP is also expected to improve from 25 per cent in 2004 to 28 per cent in 2007 as a result of better performance by both public and private sectors. Table 2.6 Gross Domestic Savings and Investment (in Per cent of GDP at current mp) As per cent of GDP

2001

2002

2003 2004 2007 Estimate Estimate Forecast Gross domestic savings (GDS) 23.5 24.2 25.0 25.0 28.0 26.2 26.0 26.0 25.5 27.0  Private sector -2.7 -1.9 -1.0 -0.5 1.0  Public sector Gross domestic Investment (GDI) 23.1 23.3 23.6 23.7 27.8 17.3 17.6 17.7 17.8 20.8  Private sector 5.8 5.7 5.9 5.9 7.0  Public sector Resource gap = (GDS-GDI) 0.3 0.9 1.4 1.3 0.2 Source: National Accounts Statistics 2004, Central Statistical Organisation (CSO) for 2001-2002 and author’s estimates/ projections for 2003-2007.

(a) Employment and un-employment (i) Employment Situation Comprehensive data on employment and unemployment are collected by the National Sample Survey Organisation (NSSO) through quinquennial surveys. As per the results of the 55th Round (1999-2000) of the NSSO Survey, employment growth rate declined from 2.43 per cent per annum in 1987-1994 to 1.07 per cent per annum in 1994-2000 (Table2.7). The decline in the rate of growth of employment in the 1990s was associated with a comparatively higher growth in GDP, indicating a decline in the labour intensity of production. It was also associated with a sharp decline in the growth rate of labor force from 2.29 per cent in 1987-1994 to 1.03 per cent in 1993-2000. Table-2.7: Employment growth rates in 1972-2000 (per cent) Period

Rate of growth of Rate of growth of labor population force (% per annum) (% per annum) 1972-1978 2.27 2.94 1977-1983 2.19 2.04 1983-1988 2.14 1.74 1987-1994 2.10 2.29 1994-2000 1.93 1.03 Source: Planning Commission, Government of India. Some

Rate of growth of employment (% per annum) 2.73 2.17 1.54 2.43 1.07

estimates of employment available from the Annual Rounds of NSSO for the July-December 2002 indicate that employment increased at the rate of 2.07 per cent per annum in 2000-2002 as compared to 1.02 per cent per annum in 1994-2000. In 2000-2002 in absolute terms, employment increased by 8.4 million per year on an

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average, as against the target of creating approximately 50 million employment opportunities over the Tenth Five-Year. A major shift in the work force structure in 1977-2000 was an increase in the proportion of casual labor from 27.2% to 33.2%, and a decrease in self-employment from 58.9% to 52.9%, while the proportion of regular salaried employment in total employment remained stationary around 13.9 per cent. The decline of self-employment in rural areas reflects the decline in proportion of farmers cultivating their own land owing to fragmentation of holdings. The increase in casual employment reflects the displacement of marginal cultivators and their conversion into agricultural labor. In 1983-2000 the share of agriculture in total employment declined from 63 per cent to 57 per cent and that of manufacturing increased from 11.6 to 12.1 per cent. In 2000, the share of construction in total employment increased to 4.4%, that of trade and transport to 15.2% and that of community services to 9.2%. In 1994-2000, trade has the highest growth rate (5.7%), followed by transport and communications (5.5%), financial services (5.4%), and construction (5.2%), whereas agriculture, mining and quarrying, and public utilities registered negative growth rates in employment. Organised sector accounted for only 9 per cent of the total employment in 1978-1994, and its share declined to 7 per cent in 1999-2000. This was entirely due to slowing down of employment in the public sector from 1.52 per cent per annum in 1983-1994 to a negative growth rate of (-) 0.03 per cent in 1994-2000. The decline of employment in the public sector could be attributed to restructuring programs of the public sector and imposition of ban on new recruitment in government departments as a part of the “economy drive” to reduce expenditure. Employment in the public sector is unlikely to expand rapidly as government is reducing its scope and many public undertakings have surplus labour. Table-2.8 Sectoral Employment in 1983 to 2000 Employment (per cent to total)

Annual growth rate (%)

Sector

1983

19871988

19931994

19992000

1983 to 19871988

Agriculture Mining & quarrying Manufacturing Electricity, gas, water Construction Trade, hotels, restaurant Transport, communication Financial, real estate Community/social services All Sector

63.2 0.7 11.6 0.3 3.0 7.6 2.9 0.9 9.8 100

60.1 0.9 11.9 0.3 4.4 8.3 3.0 1.0 10.1 100

60.4 0.8 11.1 0.5 3.5 8.5 3.1 1.1 11.1 100

56.7 0.7 12.1 0.3 4.4 11.1 4.1 1.4 9.2 100

1.8 7.4 3.6 2.9 12.1 4.9 3.2 4.7 3.6 2.9

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19871988 to 19931994 2.6 1.0 1.2 7.2 -1.4 3.0 3.5 4.5 4.1 2.5

1983 to 19931994 2.2 3.7 2.3 5.3 4.2 3.8 3.4 4.6 3.6 2.7

19931994 to 19992000 0.02 -1.9 2.6 -3.6 5.2 5.7 5.5 5.4 -2.1 1.1

Growth rate of organized private sector employment accelerated from 0.45 per cent per annum in 1983-1994 to 1.87 per cent in 1994-2000. However, this was not enough to offset the employment slowdown in the public sector, as private sector accounted for only one third of total organized employment. The employment elasticity with respect to GDP declined continuously in 1980s and 1990s. Rapid growth of employment in the organized sector depends on employment growth in the private sector. Since the potential growth of organized employment is limited, bulk of the employment growth has to come from unorganized sector. (ii) Unemployment Situation There are various concepts of unemployment viz. Usual Principal Status (UPS), Usual Principal and Subsidiary Status (UPSS), Current Weekly Status (CWS) and Current Daily Status (CDS). All these concepts of unemployment indicate that unemployment rates differ widely for rural and urban areas and for males and females. Generally, urban areas have higher unemployment rates for both males and females than rural areas. The rate of unemployment on the basis of CDS increased from 6.03 per cent in 1993-94 to 7.32 per cent in 1999-2000. Unemployment rates varied sharply across the states and inter-state variations were consistent over time. States where wages are kept higher than neighboring regions by strengthening bargaining power of labor or by provision of social security have generally high incidence of unemployment. The differentials of rural and urban unemployment rates narrowed in 1999-2000, due to sharp increase in unemployment rates for both rural males and females. One factor for this development was a shift from self-employment to casual labor.

3. Inflation (a) Movements in WPI and CPI Annual point-to-point inflation rate in terms of Wholesale Price Index (WPI) declined from 6.5% in 2002-03 to 4.6% in 2003-04. The current year 2004-05 started with an inflation rate of 4.5% on 3 April 2004 and declined to 4.3% on 24 April 2004. Since then it had generally an upward trend and stood at 7.4% on 23 October 2004 compared to 5.1% a year ago. The 52-week average inflation rate at 6.3% on 23 October 2004 is also higher than 4.9% registered a year ago. According to some economists, WPI inflation is not an appropriate index to determine the impact of price rise on the cost of living of common man. Rather, the Consumer Price Index for Industrial Workers (CPI-IW), which includes selected services and is measured on the basis of retail prices and used to determine the dearness allowance of employees in both the public and private sectors, would be an appropriate indicator of general inflation. In sharp contrast to the WPI, the CPI inflation had been stable and moderate. This is because food items constitute higher weights in CPI than in WPI and in general the price increases of these items have been moderate in the current year.

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Annual point-to-point inflation in terms of the CPI-IW declined significantly from 5.1 per cent in April 2003-04 to 3.5 per cent in March 2003-04 and further to 2.2 per cent in April 2004. The CPI inflation rate had an increasing trend since then and reached 4.8% in September 2004, compared to 2.9 per cent a year ago, but it is substantially lower than the average WPI inflation at 7.7% in September 2004. Given these trends, year end average inflation is estimated to be 6.8 per cent in terms of WPI and 5 per cent in terms of CPI in 2004. (b) Price movements of major categories At the end of 30th week of the current fiscal year, on the 23rd October 2004, for which latest information are available, point-to-point annual WPI inflation was running at 7.4 per cent and the average inflation at 6.3 per cent. High inflation was basically due to substantial price rise for minerals, petroleum products, metals and metal products induced by international prices. The annual rate of WPI inflation for primary articles (weights of 22 per cent) was 4.9 per cent caused by an inflation of 2.7 per cent for food articles, 2.9 per cent for non-food agricultural articles and 157 per cent for minerals. Prices of fuel, power, light and lubricants (with weights of 14.2 per cent), which are mostly administered, increased by 11.2 per cent, and prices of manufactured items (with weights of 63.8 per cent) increased by 7 per cent mainly due to an increase of sugar prices by 14.2 per cent, basic metals and metal products by 20.3 per cent, particularly iron and steel prices by 26.1 per cent. Prices of other manufactured items remained moderate. Given these trends, the annual average rate of WPI inflation in 2004 is expected to remain in the range of 6.8 per cent, up from 5.4 per cent in 2003, mainly due to sharp increase in prices of minerals, petroleum products, metals and iron and steel induced by rise of domestic production cost and hardening of international prices of these goods. The CPI inflation rate ranged between low to moderate in 2004 and reached 4.8 per cent in September 2004. The average CPI inflation is expected to remain around 5 per cent in 2004 compared to around 4 per cent in 2002 and 2003. (c)Determinants of inflation Decomposition of inflation rates indicates that minerals in the primary group, petroleum products, and sugar, metals, metal products, particularly iron and steel under the manufactured prices witnessed relatively higher price increases and contributed most to the inflation in 2004. Inflation for the non-food manufactured items (except for iron and steel) was moderate showing considerable correlation with global prices and was the result of complete removal of quantitative restrictions (QRs) and other non-tariff barriers on imports and continual reduction of import duties in India to fulfill requirements under the general agreements with the World Trade Organisation. Thus, high inflation was not wide spread and was concentrated in a few commodities related to minerals and metals. Prices of these commodities are influenced not only by

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domestic supply and demand but also by international prices. In general, there had been hardening of international commodity prices due to revival of world growth. There were neither supply constraints nor demand-pull in the domestic market. Inflation in petroleum products, minerals, metals and their products appear to be cost-pushed and driven by international prices. Broad money supply growth was around RBI target rate of 14% and did not pose any problems, as it was accompanied by significant improvement in industrial and infrastructure production. Government fiscal deficit was under control and within budget targets. Ministry of Finance reduced customs and excise duties of selected petroleum products and reduced customs duties of non-alloy steel and ships for breaking. Given the fact that there was no demand-pull, and the high inflation was mainly cost-pushed, RBI did not adopt a restricted or contractionary monetary policy. It made marginal upward revision of cash reserve ratio and repo rate (overnight lending of cash) without any change of the bank rate. Table 3.1 Average Inflation Rate in terms of Wholesale Price Index (per cent) Major Groups

Weights (per cent)

2002 Average

2003 Average

Annual Inflation Point-topoint on 23-10-2004

All commodities 1. Primary articles  Food items  Non-food items  Minerals 2. Fuel, power & lubricants 3. Manufactured products  Sugar group  Edible oils  Cotton textiles  Leather products  Chemicals & products  Cement  Basic metal & alloys  Iron and steel  Machinery and tools  Transport equipment

100.0 22.0 15.4 6.1 0.5 14.2 63.8 3.9 2.8 9.8 1.0 11.9 1.7 8.3 3.6 8.4 4.3

3.4 3.4 1.7 8.3 -0.4 5.6 2.8 -7.9 22.3 -1.1 -2.0 2.9 -2.2 1.5 5.1 0.9 0.5

5.5 4.3 1.2 12.6 2.1 6.4 5.7 3.5 14.4 7.7 12.9 1.9 1.2 15.6 26.3 1.8 -0.1

Actual 7.4 4.9 2.7 2.9 157.2 11.2 7.0 14.2 1.0 6.5 4.4 3.4 5.0 20.3 26.0 6.7 5.7

2004 Average Estimate

6.8 4.2 2.0 3.0 150 11.5 6.8 14.0 1.0 6.0 4.5 3.5 5.0 20.0 25.0 6.0 6.0

Table 3.2 Average Inflation Rate in terms of Consumer Price Index (per cent) Major Groups

General 1. Food 2. Tobacco & intoxicants 3. Fuel and light 4. Housing 5. Clothing and footwear

Weights (per cent)

2002 Actual

2003 Actual

100.0 57.0 3.2 6.3 8.7 8.5

4.0 2.1 1.7 8.6 6.2 1.7

3.9 4.1 3.9 8.0 6.7 2.3

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Annual Inflation At end Sept 2003 4.8 1.8 2.0 11.0 10.0 5.0

2004 Estimate 5.0 2.0 2.5 11.5 10.0 5.0

6. Miscellaneous group

16.4

4.7

4.6

5.0

5.0

The Government’s anti-inflationary policies in recent years included a strict monetary and fiscal discipline, an effective management of supply and demand for essential consumer goods and raw materials through liberal imports, and strengthening of the public distribution system for food grains, sugar and kerosene oil. Successive budgets provided various fiscal concessions and extended the value added tax to ensure that indirect taxes do not unduly add to the prices of essential items. There was also a distinct improvement in the supply of manufactured items by sustained industrial growth and of stocks of food grains due to continued government procurement. (d) Inflation Outlook The medium-term inflation risks are manageable. Given government’s commitment to economic reforms, strict fiscal prudence, monetary discipline, orderly movement of the exchange rate of rupee, continued reduction of import duties and other indirect taxes, and removal of all quantitative restrictions on the imports of consumer goods, the annual inflation rate in terms of both wholesale and consumer price indices is likely to have a declining trend in the medium term and to remain around 4 per cent in 2005-2007. (a)

4. Trade and Exchange Rates Exports and Imports in 2000 and 2001

Indian exports remained buoyant with a growth of 19.9 per cent in 2003 due to an increase of exports of both primary and manufactured products. India emerged as the fastest growing exporter after China among the leading exporting countries. Imports increased by 21.8 per cent in 2003 driven by pick up industrial activities and investment demand. The net result was a decline in the trade deficit from 2.5 per cent of GDP in 2002 to 2.7 per cent of GDP in 2003 (Table 4.2). The net invisible surplus improved from 3.3 per cent of GDP in 2002 and to 4.2 per cent in 2003 with buoyant private transfers and software exports commensurate with global recovery. Consequently, the current account balance (including official transfer) was in surplus for the third consecutive year in 2003 and amounted to 1.4 per cent of GDP. Export growth in terms of US dollar accelerated from 8.8 per cent in April-September 2003 to 24.4 per cent in April-September 2004, while imports growth accelerated from 21.4 per cent in April-September 2003 to 34.3 per cent in April-September 2004 contributed by a growth of oil imports by 57.8 per cent and that of non-oil imports by 25.8 per cent. As a result, trade deficit increased from $7.4 billion in April-September 2003 to $12.7 billion in April-September 2004. Given these trends, exports are expected to achieve a growth of 20 per cent in 2004 (Table 4.1) due to buoyancy in world demand, resurgence in world trade and improvements in world commodity prices. In addition, various export facilitating measures, good performance in key manufacturing sectors like engineering goods, chemicals, automobiles, ore and minerals, basic metals and petroleum products also contributed to the growth of exports. Imports also recorded a substantial growth by 21 per 19

cent in 2004 mainly due to higher imports of crude oil, export related products, and capital goods imports. As a result, trade deficit as a per centage of GDP is expected to increase from 2.7 per cent in 2003 to 3 per cent in 2004. Net invisible earnings are expected to have a robust growth of 18 per cent in 2004 and amount to 4.3 per cent of GDP in 2004. The overall current account balance is once again expected to have a surplus amounting to 1.3 per cent of GDP in 2004, almost the same level as in 2003. Table 4.1 Trends of Foreign Trade Foreign trade Merchandised exports Merchandised imports Services exports Services imports

Value in US$ million 2003 62952 79658 51939 26514

Value in US$ million 2004 Est. 75542 96386 58635 28635

Growth rate 2002 (Per cent) 16.9 13.5 18.2 13.4

Growth rate 2003 (Per cent) 19.9 21.8 19.7 0.7

Est. GR 2004 (Per cent) 20.0 21.0 12.9 8.0

Source: RBI Annual Report 2003-2004 for the years 2002-2003, and author’s estimate for 2004. Table 4.2 Trade and Current Account Balance Items Merchandised trade balance Net invisible balance Current account balance Net capital inflows Overall balance of payments

2002 US$ Million -12910 17047 4137 12843 16980

2002 As % Of GDP -2.5 3.3 0.8 2.5 3.3

2003 US$ Million -16706 25425 8719 22703 31421

2003 As % of GDP -2.7 4.2 1.4 3.7 5.1

2004Est US$ Million -20844 30000 9156 10650 19806

2004Est As % of GDP -3.0 4.3 1.3 1.5 2.9

Source: RBI Annual Report 2003-04for the years 2002-2003 and author's estimate for 2004. (b)

Composition of Trade

The share of primary products in total exports declined continuously from 24 per cent in 1996 to 16 per cent in 2000 and further to 15 per cent in 2003-2004 due to continual decline of share of agricultural exports from 20 per cent in 1996 to 11 per cent in 2004. The share of minerals in total imports increased marginally from 3 per cent in 1999-2001 to 4 per cent in 2002-2004. The share of manufactured items in exports decreased from 81 per cent in 1999 to 77 per cent in 2004. The major exports of manufactured goods consisted of engineering goods, chemicals and chemical products, iron and steel, drugs and pharmaceuticals, labor intensive products such as gems and jewellery, textile products, readymade garments and handicrafts, and also traditional categories of leather and leather products. In recent years, software exports and petroleum products have emerged as major export earners and accounted for 12 per cent of total exports in 2004.

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There was significant change in the composition of imports in 1997-2000, but the composition remained more or less unchanged in 2000-2004. Share of bulk imports, which consist of crude oil, petroleum products and other consumption goods and some key raw materials and intermediate goods, declined significantly from 41 per cent in 1997 to 31 per cent in 1998, but it continuously increased and regained its share around 40 per cent in 2004 due to substantial increase in imports of petroleum, oil and lubricants (POL) from 17 per cent in 1998 to 31 per cent in 2004. Share of bulk consumer goods declined from 7 per cent in 1998 to 4 per cent in 2004. Share of other bulk imports which consist of fertilizers, non-ferrous metals, paper, rubber, pulps, ores, iron and steel declined continuously from 12 per cent in 1998 to 7 to 8 per cent in 2002-2004. Non-bulk items, which consist of capital goods, precious stones, export related products, chemicals and chemical products, textiles, plastics, scientific instruments and medicines constituted 62 per cent of total imports in 2004 compared with 61 per cent in 2001. Share of capital goods declined continuously from 25 per cent in 1996 to 12 per cent in 1999, followed by an increasing trend thereafter and reached 22 per cent in 2002-2004 driven by investment demand. Share of export related products remained stable around 17-18 per cent in 1996-1999 but declined to 16 per cent in 2001-2004. Share of other non-bulk items which consist of gold and silver, plastics, scientific instruments, coal and coke, medicines and drugs, chemicals and non-metallic mineral products increased continuously from 17 per cent in 1996 to 38 per cent in 2004. (c)

Direction of Trade

There were significant changes of direction of trade in 2000-2004 compared with that in 1990s. Destination of exports changed with lower shares of OECD countries and higher shares of African and Asian developing countries. Asia and Oceania has now emerged as major partners of Indian trade. The sources of imports have also undergone significant changes in recent years. Imports from the USA and EEC declined marginally, that of OPEC countries declined significantly from 23 per cent in 1999 to 6 per cent in 2004, while imports from developing Asian and African countries increased substantially and those from of Japan and East Europe remained more or less unchanged. Another major feature of the Indian direction of trade was that India’s trade with the South East Asian region, particularly with China, Hong Kong, Indonesia, Korea, Malaysia, Thailand and Singapore increased significantly in 2000-2004, as these countries recovered from the exchange rate, financial and economic crisis of 1997-1999.

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Table-4.3: Composition of India’s Exports (per cent) Commodity Groups 1.

Primary products 1.1 Agriculture/ allied 1.2 Ores and minerals 2.Manufactured products 2.1 Leather & products 2.2 Chemicals & prod. 2.3 Engineering goods 2.4 Textiles 2.5 Gems and jewelry 2.6 Handicrafts 2.7 Carpets 2.8 Others 3. Petroleum & lubricants 4. Others as unclassified Total exports

1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14.

Commodity Groups Food and allied products Fuels- Coal and POL Fertilizers Paper and newsprint Capital goods Chemicals Precious metals Iron and steel Non-ferrous metals Professional instruments Gold and silver Ores Textile yarn & fabric Others as unclassified

Total exports

1999

2000

2001

2002

2003

2004

18 15 3 81 4 13 14 25 21 2 2 9 0 2 100

16 14 3 77 4 13 15 24 17 2 1 2 4 3 100

16 13 3 76 4 14 16 22 17 1 1 1 5 3 100

17 13 4 76 4 14 17 21 17 1 1 1 5 2 100

15 12 4 75 3 15 19 19 17 1 1 0 6 4 100

15 11 4 77 3 15 19 20 17 1 1 1 6 2 100

2003 4 28 1 1 22 6 9 2 1 2 9 2 2 11

2004 4 31 1 1 21 7 10 2 1 2 8 2 2 8

100

100

Table-4.4: Composition of India’s Imports (per cent) 1999 2000 2001 2002 6 4 5 4 27 34 30 31 3 2 1 1 1 1 1 1 12 18 19 22 8 7 8 7 11 10 9 10 2 1 2 2 1 1 1 1 2 2 2 2 10 9 9 7 2 2 2 2 1 1 1 1 15 8 10 8

100

100

100

100

Table-4.5 Direction of India’s Foreign Trade 1990-1999 (per cent) Region/ Country 1. 2. 3. 4. 5. 6. Total

West Europe East Europe Asia and Oceania Africa America Non-specified countries

Destination of exports: 2002 24 3 43 6 25 0 100

2003 24 3 46 6 21 0 100

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2004 24 3 44 6 23 0 100

Sources of Imports: 2002 25 2 29 6 10 28 100

2003 24 2 35 4 9 26 100

2004 24 3 36 4 10 23 100

(d)

Trade and Tariff Policies

The Medium Term export Strategy (MTES) announced in 2002 set out a road map for the Indian exports in the Tenth Five Year Plan (2002-2007). The MTES aims at increasing India’s share in world trade from the present level at 0.8 per cent to one per cent by 200607. This implies doubling of India’s exports in this period. Export market diversification is a major objective of MTES and the Export-Import (EXIM) Policy with special focus on sub-Saharan Africa and the Commonwealth of Independent Nations. The modified Five Year EXIM policy for the period 2002-2007 announced in January 2004 aimed at consolidation and acceleration of exports growth so as to make India a manufacturing hub for producing quality goods and services. Measures focused on simplification of operational procedures and imparting greater transparency with for reduction of transaction costs for exports. Some restrictions on imports of gold and silver, electrical energy and air guns were removed. Under the duty free replenishment certificate (DFRC) scheme, duty free import of fuel was allowed with actual user conditionality. Procedures for Export Promotion Capital Goods (EPCG) scheme were simplified. Deemed exports benefits were granted for fertilizers, refinery products and items attracting zero per cent customs duty. Various measures were announced to boost exports. Facilities for special Economic Zones (SEZs) were widened. A new trade policy called the National Foreign Trade Policy 2004-09 was announced on August 31, 2004 with an objective of doubling India’s share in global trade by 2009 and to act as an effective instrument of economic growth by giving thrust to employment generation, particularly in semi-urban and rural areas. Key strategies included removal of all controls, simplification of rules and procedures and identification of focus areas with potentials for both employment generation and exports. Special package for agriculture included duty free imports of capital goods and seeds, special funds for Agri Export Zones and incentives for exports of fruits, vegetables, flowers and forest products. Special incentives were announced for exports of gems and jewellery, handlooms and handicrafts and leather products. To encourage service exports, existing scheme of utilizing a part of export earnings for importing related items was revamped and hotels were allowed to use their duty credit entitlement for import of food items and alcoholic beverages. Other important measures included the following:      

EPCG scheme was liberalized for service providers. Import of fuel under DFRC entitlement was allowed to be transferred to marketing agencies. Export Oriented Units (EOUs) were exempted from service tax. A new scheme was announced to establish Free Trade and Warehousing Zones and FDI to the extent of 100% was allowed for establishment of such zones. Imports of second hand capital goods were allowed without any age restrictions. A Service Exports Promotion Council was established.

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(e)

Exchange rate policies

In international categorizations by the International Monetary Fund (IMF), India is regarded as one of the countries having independent floating exchange rate arrangement. The day to day fluctuations in the exchange rate of Indian rupee are determined by free market forces for supply and demand for foreign exchange; such fluctuations reflect both economic fundamentals and short term speculation. The rupee is also fully convertible on current account and almost fully convertible on capital account for the non-residents. The year 2004 posed several challenges for the exchange rate management in the face of the continued increase in international prices of crude oil and petroleum products and substantial rise of Indian oil import bill. The broad principles that guided India’s exchange rate policy include the following: • • •

Careful monitoring and management of exchange rates without a fixed target or a pre-announced target or a band. Flexibility in the exchange rate together with ability to intervene, if and when necessary; A policy to build a higher level of foreign exchange reserves which takes into account not only anticipated current account deficits but also ‘liquidity at risk’ arising from unanticipated capital movements; A judicious policy for management of capital account.

In 2004 government further liberalized the movement of cross-border capital flows, especially in the area of outward foreign direct investment, inward direct and portfolio investment, non-resident deposits and external commercial borrowings. Other policies include the following:  FDI limit was raised from 40% to 49% in civil aviation.  Tax was imposed on interest earned on the deposits by the Non-Resident Indians.  Interest rates on public provident funds and small savings were maintained at 8%. • Prepayment of External Commercial Borrowing by the corporates was allowed without any limit. Rupee depreciated by 6.3 per cent in April-July 2004. But these interventions along with huge foreign exchange reserves and continual depreciation of US dollar vis-à-vis major international currencies led to an appreciation of the Indian rupee by 2 per cent in terms of US dollar in August-November 2004. Given these trends, rupee is expected to depreciate marginally in terms of US dollar in 2004. The nominal effective exchange rate of rupee (NEER) depreciated by 8 per cent in 20022003 followed by an depreciation by 1.8 per cent in 2004. The real effective exchange rate (REER) of the rupee depreciated by only 2.4 per cent in 2002-2003 and appreciated in 2004 due to widening price differentials between India and its major trading partners. The high level of REER has become an issue of some concern as the authorities try to find ways to promote exports, and the recent appreciation of the rupee in both nominal and real terms had reduced the competitiveness of the Indian exports in international markets.

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5. Capital inflows and outflows (a) Balance of Payments Despite difficult international environment and hardening of international prices of crude oil, India’s external trade and payments situation in recent years was marked by a noticeable structural change towards a more stable and sustainable balance of payments. There was continual improvement in the invisible account and in the coverage of import payments through export earnings. The current account earned surplus every year since 2001, and the surplus as a percentage of GDP increased from 0.2 per cent in 2001 to 1.4 per cent in 2003-2004. In the capital account, there was a major shift in favor of long-term and non-debt creating financial flows such as FDI and portfolio investment. Table 5.1 Net Capital inflows (in US$ million) Net capital inflows 2001 2002 2003 2004 Est. External assistance, net 1117 -2480 -2661 1900 Foreign direct investment (FDI), net 4741 3611 3137 3500 Portfolio investment, net 1951 944 11355 1000 Commercial bank credits, net -1576 -2344 -1853 850 Other capital inflows, net 4743 13112 12725 3700 Total capital inflows, net 10976 12843 22703 10950 Official grants 384 410 559 500 Capital inflows including grants 11360 13253 23262 11450 Source: RBI Annual Report 2003-2004 for the years 2002-2003, and author’s estimate for 2004.

(b) Foreign investment Foreign investment inflows (as per balance of payments definition) increased two and half times from $4.5 billion in 2002 to $14.5 billion in 2003 attracted by the sound macro economic environment in India, the stability of the exchange rate of rupee, further liberalization of foreign investment policies, and relatively high return of investment in India compared to other host countries. The increase was attributable to increases in both direct foreign investment and portfolio investment as a result of upgrading of Indian scrip by some international credit rating organizations and bullish stock exchange markets at home. Foreign investment inflows declined to $4.5 billion in 2004 due to decline of portfolio investment mainly influenced by political economy and bearish stock markets in the first half of 2004. The source and direction of foreign direct investment flows remained by and large unchanged in the 1990s. Companies registered in Mauritius and the USA were the principal source of foreign direct investment in India in 2000-2003 followed by United Kingdom, Japan and Germany (Table 5.3). The bulk of foreign investment went into computers (both hardware and software), engineering industries, services, electronics and electrical equipment, chemicals and allied products, food and diary products (Table 5.4).

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Table 5.2 Foreign Investment Inflows (in US$ million) Items 2000 2001 2002 2003 2004-Est. A. Foreign Direct Investment (FDI) 4029 6131 4660 4675 3500 1456 2221 919 928 800  Through govt. approval 454 767 739 534 500  RBI automatic route 67 35  NRI investments 423 1072 1042 735 600  Acquisition of shares 1629 2036 1960 1800 1600  Reinvested earnings B. Portfolio investment 2760 2021 979 11377 1000 831 477 600 459 200  GDRs/ ADRs 1847 1505 377 10918 800  FIIs 82 39 2  Off-shore funds C. Total Foreign Investment 6789 8152 5639 16052 4500 Note: Data in this table donot tally those in the balance of payments table due to differences in definitions. Table 5.3: Country wise inflows of foreign Direct Investment (US $ million) Home country 1999 2000 2001 2002 2003 Germany 31 113 74 103 69 United Kingdom 112 61 45 224 157 Japan 142 156 143 66 67 Mauritius 501 843 1863 534 381 Netherlands 82 76 68 94 197 South Korea 8 24 3 15 22 USA 355 320 364 268 297 Others 350 317 428 354 272 Total 1581 1910 2988 1658 1462 Note: FDI inflows in this table include only those through government approval and RBI automatic route. Table 5.4: industry-wise inflows of foreign Direct Investment (US$ million) Sectors 1999 2000 2001 2002 2003 Chemical & allied 120 137 67 53 46 Computers 99 306 368 297 151 Engineering 326 273 231 262 274 Electronics & electricals 172 213 659 95 103 Finance 20 40 22 54 5 Food & diary products 121 75 49 35 63 Pharmaceuticals 54 62 69 44 79 Services 116 226 1128 509 431 Others 553 578 398 309 311 Total 1581 1910 2988 1658 1462 Note: FDI inflows in this table include only those through government approval and RBI automatic route.

(c) Foreign Exchange Reserves After a build up of foreign exchange reserves (including gold and SDR) by $17 billion in 2002, there was a substantial build up of the foreign exchange reserves by $31.4 billion in 2003, and further by $19.8 billion in 2004. This was mainly due to improvement in current account balance. The stock of foreign exchange reserves (including gold and SDR) stood at $121 billion at the end of October 2004 and is estimated to increase to $122 billion equivalent to 15.2 months of imports at the end of March 2005, from $102 billion equivalent to 15.4 months of imports at the end of March 2004.

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The policy for reserve management is judiciously built upon a host of identifiable factors and other contingencies. Such factors include the size of the current account deficit; the size of short-term liabilities; the possible variability in portfolio investment and other types of capital flows; the unanticipated pressures on the balance of payments arising out of external shocks; and movements in the repatriable foreign currency deposits of NonResident Indians (NRIs). Taking these factors into account, India’s foreign exchange reserves are at present comfortable and consistent with the rate of growth, the share of the external sector in the economy and the size of risk-adjusted capital flows. It may also be mentioned that most of the increase in reserves in recent years is through net purchases by RBI in the domestic forex market, for which an equivalent amount of domestic currency has been released to the concerned domestic entities, including public sector units, corporate bodies and individuals. The decision on the use of this counterpart domestic currency released by RBI (i.e., for investment, deposits or as liquid assets, etc.) is the responsibility of the entities. Needless to add that to the extent this counterpart local currency is used by recipient entities for further investment in the economy, the impact on industrial demand and growth would be favorable. (d) External debt and debt-service Trends of various debt indicators such as debt/GDP and debt/service ratios indicate a marked improvement in India’s external indebtedness. India’s external debt consisting of both short-term and long-term liabilities on Government and non-Government accounts increased from $104.9 billion at the end of March 2003 to $112.6 billion at the end of March 2004, and is expected to increase to $114.5 billion at the end of March 2005. Multilateral and bilateral debt constituted 44 per cent of total debt stock and the share of concessionary debt was 36 per cent of the total debt stock in 2004. The share of short-term debt declined continuously in recent years, and stood at 2.5 per cent of total external debt in 2004. India improved its rank among the top 15 debtor countries from third in 1991 to eighth in 2002. Importantly, among the top 15 debtor countries, India’s short-term debt to foreign exchange reserve ratio are the lowest. The changing composition of capital account in favor of non-debt financial flows led to an impressive improvement in debt indicators. The debt-to-GDP ratio declined continuously from 38 per cent in 1991 to 18.4 per cent in 2003 and further to 16.6 per cent in 2004. The debt-service ratio (i.e. the ratio of total debt services to gross receipts on the current account of the external sector) also declined continuously from 35 per cent in 1990 to 18.3 per cent in 2003 and further to 13.5 per cent in 2004. The World Bank now classifies India as a “low indebted country”. On considering high transactions cost and stringent conditionalities, and the present level of foreign exchange, previous government took a policy decision in 2003 to borrow only from 5 bilateral countries viz. Japan, UK, Germany, USA and Russian Federation. However, the new government after taking charge in June 2004 removed conditionalities of country origin for borrowing. India is also participating actively in the international

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initiative for economic development of HIPC (Heavily Indebted Poor Countries) and other developing countries. Under the HIPC, India is providing credit lines to seven eligible HIPC countries viz. Mozambique, Tanzania, Zambia, Ghana, Guyana, Nicaragua and Uganda. The government has waived the outstanding dues from these countries. In addition India provides credit lines to a number of developing countries. 5.5 Outstanding External Debt (millions of US dollars) Items

March 2002

March 2003

March 2004

March 2005 Proj. 114507 109507 46103 63404 5000

External debt 98757 104869 112593 Long term 96012 100300 107857 Public 43619 43716 44303 Private 52393 56584 63554 Short term 2745 4569 4736 Debt services In US dollars 10863 14407 20949 17000 As % of gross exports 13.4 15.1 18.3 13.5 As % of GDP 2.3 2.8 3.4 2.5 Source: Status Report on India’s External Debt, June 2004, Ministry of Finance and Reserve Bank of India Annual Report 2003-04 for the years 2002-2004, and author's estimate for 2005.

(e) Outlook for the External Sector for 2004-2006 Assuming a moderate depreciation of the real effective exchange rate for Indian rupee in 2005-2007, India’s trade performance is expected to improve in response to a recovery in international economic activity, trade deepening, and further integration of the country into the global economy. Exports in terms of US dollar are projected to grow by 16 per cent on an average per annum in 2005-2007 while imports are likely to grow by 17 per cent in the period. The trade deficit as per centage to GDP is expected to remain in the range of 3.4 to 4 per cent of GDP and the invisible surplus is expected to remain around 4.3 per cent of GDP in 2005-2007 due to sustained growth in remittances from abroad. Consequently, the current account balance is expected to generate marginal surplus in the range of 0.2 per cent to 0.5 per cent of GDP in 2005-2007. On capital account, access to commercial markets would be renewed as international credit ratings improve, and the composition of capital inflows would continue to shift in favor of non-debt creating financial flows in response to the sustained reforms in industry, infrastructure and factor markets. Total capital flows are expected to increase from 1.5 per cent in 2004 to 1.7 per cent of GDP in 2007 and flows of foreign investment to remain at 1 per cent of GDP in the period. The stock of foreign exchange reserves is expected to increase from $122 billion equivalent to 15.2 months’ imports at the end of 2004 to $178 billion equivalent to 14 months’ imports at the end of 2007. The stock of external debt is expected to increase to $120 billion amounting to 13.3 per cent of GDP at the end of 2007. The debt-service ratio would remain at its normal level around 10 per cent in 2005 (despite maturing of the India Millennium Bonds in 2005,

28

which were issued to non-residents in 2000 and generated $5.5 billion) and decline to 9.3 per cent of current receipts (exports and gross invisibles) in 2007. 6. Fiscal Developments (a) Fiscal situation in 2003 and 2004 Tax revenues of the Central government in 2003-04 RE exceeded BE by 1.8% (due to higher realisation of corporate tax), and non-tax revenues also exceeded BE by 8.2% (due to higher realisation of dividends and grants). Total expenditure exceeded BE by 8%. While revenue expenditure was short of BE by 0.9%, capital exp exceeded BE by 53.5%. Defense, interest payments and subsidies lower than BE by Rs.12, 946 crore. Consequently, there was an improvement in fiscal deficit to 4.8% of GDP in 2003-04 RE from BE at 5.6% of GDP, and improvement in revenue deficit to 3.6% of GDP in 200304 RE from BE at 4.1% of GDP. The Union Budget for 2004 continued the on-going fiscal adjustment by targeting the fiscal deficit at 4.4 per cent of GDP and attempted to stimulate balanced growth of agriculture, industry and services. Fiscal policies included rationalization of customs and excise duties and reduction of the maximum tariff rate from 30 per cent to 25 per cent. The Budget attempted to stimulate the economy by leaving direct taxes unchanged and increasing public expenditure on agriculture, infrastructure and rural development. Policies were announced to promote agri-business, small enterprises and rural development. Budget had also a strong commitment to the development of social sectors for achieving distributive justice, strengthening the public distribution system and poverty alleviation programs, improving rural infrastructure and generation of employment. Welfare schemes for the poor included the following: • Additional plan outlay of Rs.10, 000 crore for Food for Work Program, sarva Shiksha Abhiyan, Mid-day Meal scheme, basic health care, drinking water etc. • Antyodaya Anna Yojana expanded to 2 crore families. • Strengthening of public distribution system. • A new Food for Work Program in 150 backward districts. • Allocation of Rs.1180 crore for programs concerning SCs, Rs.1146 crore for STs, additional Rs.50 crore for minorities. • A special Group Insurance Scheme of Rs.10, 000 at a premium of only Rs.120 per person. • A new Universal Health Insurance Scheme for poor. • An education cess of 2% on taxes. • No tax for individuals with taxable income up to Rs.1 lakh. • Tax holiday extended to rural hospitals and agro processing industries

Major fiscal measures announced in the budget for 2004 include the following: Fiscal consolidation: • • • • • • •

Fiscal deficit targeted at 4.4% of GDP in 2004-05 BE compared to 4.8% in 2003-04RE. Revenue deficit targeted at 2.5% compared to 3.6% in 2003-04 RE. Primary deficit kept at the same level at 0.3% of GDP in 2004-05 BE as in 2003-04 RE. Blue print to target subsidies to be prepared. Rate of interest on central government loans to states reduced from 10.5% to 9%. States would be allowed to raise fresh loans and repay high cost loans. Passing on external loans to States on a back-to-back basis.

29

30

Tax reforms: • • • • • • • • • • • • • •

Value Added Tax will be introduced at the state levels w.e.f. April 1, 2005. No one with a taxable income up to Rs.1 lakh is required to pay income tax. Acquisition of agricultural land is exempted from capital gains tax. Tax on long-term capital gains abolished. Instead, a tax on transactions in securities on stocks to be levied at the rate of 0.15%. Service tax rate increased to 10% and more services brought under the tax net. Tax exemptions on NRE accounts abolished. Gifts from unrelated persons to be taxed. Customs duty on non-alloy steel reduced from 15 to 10%, Peak rate on alloy steel, copper, zinc and base metals reduced to 15% and customs duty on raw materials and minerals reduced to 15%. Tractors and agricultural implements are fully exempted from import duties. Import duty on refined palm oil raised to 75%, that on crude palm oil retained at 65%. Excise duty reduced from 16 to 8% on meat, poultry, and fish preparations. Aids for physically handicapped persons fully exempt from import duty.. Full excise duty exemptions for computers

New tax regime for textiles: • • • •

Mandatory CENVAT chain abolished. No mandatory excise duty on pure cotton, wool, silk, whether it is fiber, yarn, fabric or garment. Blended textiles and pure non-cotton to have different tax regime. Mandatory excise duty on man-made fiber at 16%, polyester filament yarn at 24% and other manmade filament yarn at 16%.

The tax-GDP ratios of the Centre suffered a steady deterioration in 1990s (Table-6.1) reflecting a decline in tax buoyancy. The restructuring of both direct and indirect taxes effected since 1991 coupled with a structural shift in the composition of GDP towards the less taxed services sectors affected adversely the growth of tax revenues. However there has been some increase in the ratios of non-tax revenues to GDP due to restructuring of public sector enterprises and rationalization of user charges for public utilities such as power, water and transport. For medium term management of the fiscal deficit, the government passed a Fiscal Responsibility Bill in the parliament. The Bill proposes limit on fiscal deficit, limit on government borrowing, limit on total stock of public debt and complete elimination of deficit on the current account of the Budget within next five years. Table-6.1 Gross Revenue Receipts of the Central government (as % of GDP) Year 1990-91 1995-96 2000-01 2001-02 2002-03 2003-04 2004-05

Income tax 0.9 1.3 1.5 1.4 1.5 1.5 1.6

Major Taxes Corporatio Excise n tax duties 0.9 4.3 1.4 3.4 1.7 3.3 1.6 3.2 1.8 3.5 2.3 3.6 2.4 3.7

Customs duties 3.6 3.0 2.3 1.8 1.8 1.8 1.9

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Gross tax revenue

Non-tax revenue

10.1 9.4 9.0 8.1 8.8 9.3 9.8

2.1 2.4 2.7 3.0 3.0 2.7 2.3

Total revenue receipts 12.2 11.8 11.7 11.1 11.7 12.0 12.1

In the first half of 2004 i.e. April-Sept 2004 tax revenues amounted to only 33.3 per cent of the budget estimates (BE) for the year, while non-tax revenues amounted to 38 per cent of BE. However, personal income taxes increased by 73 per cent and service tax by 69 per cent in April-Sept 2004 over April-Sept 2003. Due to various economy measures, total expenditure was generally under control and amounted to 41 per cent of BE (Table 6.2) and the fiscal deficit amounted to 39 per cent of the budget estimate. Table 6.2 Union Government Account in April-September 2004 Items 1.Revenue receipts (2+3) 2.Tax revenue 3.Non-tax revenue 4.Capital receipts 5.Non-debt cap.receipts Interest payments 6.Other capital receipts 7.Total receipts (1+4) 8.Total expenditure (9+10) 9.Revenue expenditure 10.Capital expenditure 11.Revenue deficit 12.Fiscal deficit 13.Primary deficit 14.GDP at current mp

BE Actual As % BE As % RE As % Rs.billion Rs.billion of BE of GDP of GDP 3093 1065 34.4 9.7 3.3 2339 779 33.3 7.3 2.4 754 286 38.0 2.4 0.9 1685 891 52.9 5.3 2.8 311 358 115.2 1.0 1.1 1295 554 42.8 4.1 1.7 1374 532 38.7 4.3 1.7 4778 1956 40.9 15.0 6.1 4778 1956 40.9 15.0 6.1 3855 1665 43.2 12.1 5.2 923 291 31.5 2.9 0.9 761 600 78.7 2.4 1.9 1374 532 38.7 4.3 1.7 79 -22 -27.4 0.2 -0.1 31825 31825 100.0 100.0

Fiscal deficit in the first half of the year accounted for 39% of the government's estimate for the year. The revenue deficit reached 78% of its end of year target, largely as a result of slow growth. This has increased concerns that the government's plans to bolster public spending in infrastructure, education, and rural development may increase fiscal deficit. An expected rise in interest rates could further harm the fiscal position and the government may feel more pressure to press ahead with its plans to strengthen the tax system and its divestment programme. Given these developments, the actual fiscal deficit of the Central Government in 2004 is likely to be contained at 3.6 per cent of GDP compared with the budget estimate at 4.3 per cent of GDP (Table 6.3). Although both non-tax receipts and personal income taxes were buoyant, the performance of indirect taxes was poor due to weaker growth of excise duties than expected. There was also a shortfall in realization of disinvestment targets due to the lack of agreement regarding the mode of disinvestment among the political parties. (b) Fiscal Deficit and Financing Combined fiscal deficit of the Centre and State governments decreased from 9.9 per cent of GDP in 2001 to 9.5 per cent of GDP in 2002 and further to 9.4 per cent of GDP in 2003 and is budgeted to decrease to 7.9 per cent of GDP in 2004 (Table 6.4). However,

32

given the present trends of expenditures and revenues, actual fiscal deficit of the general government might reach 9.6 per cent of GDP in 2004, almost the same level as in 2003. Market borrowings emerged as the major financing item of the fiscal deficit of the central government since the mid 1990s with a corresponding decline in the shares of other liabilities and external finance (Table-6.5). There was net outgo in external finance in 2002-03 due to pre-payment of a part of external debt borrowed from the multilateral and bilateral organizations. Among domestic sources, amounts mobilized through small savings and provident funds have generally been at higher costs than the market borrowings. The share of market borrowing in financing fiscal deficit of the states also increased in 1990s with a corresponding decline in that of loans from the central government (Table-6.6). However, the receipts of small savings remained the major source of financing. 6.3 Fiscal Situation of the Central Government (As % of GDP) Central government budget 2001 2002 2003 2004 2004 as per cent of GDP Rev.Est. (BE) Est. 1. Tax revenue 5.9 6.5 6.7 7.3 8.1 2. Total non-debt revenue 9.7 10.9 12.2 10.7 11.1 3. Current expenditure 13.2 13.8 12.9 12.1 11.2 4. Total expenditure & net lending 15.9 16.8 16.9 15.0 14.7 5. Overall budget balance (2-4) -6.2 -5.9 -4.7 -4.3 -3.6 Source: Central Government Budget 2004-2005, Ministry of Finance for the years 2001-2004 and author’s estimates for 2004. 6.4 Fiscal Deficit of Centre and States combined (as per centage of GDP) Items 2001 2002 2003 2004 Rev.Est. (BE) 1. Gross fiscal balance [Deficit ( -)] 9.9 9.5 9.4 7.9 2. Revenue balance [Deficit ( -)] 7.0 6.6 6.2 4.0 3. Primary balance [Deficit ( -)] 3.7 3.3 2.9 1.7

2004 Est. 9.6 6.2 3.2

Table-6.5 Financing of gross fiscal deficit of the central government (in per centage) Sources of financing 1990-91 1995-96 2002-03 2003-04 2004-05 RE BE 1. Domestic finance (a+b+c) 92.9 99.5 108.2 108.9 94.1 (a) Market borrowings 17.9 54.9 71.8 64.9 65.8 (b) Other liabilities 49.5 28.3 35.2 51.8 18.5 (c) Use of cash with RBI 25.4 16.3 1.3 -7.8 9.9 2. External finance 7.1 0.5 -8.2 -8.9 5.9 3. Total (1+2) 100 100 100 100 100 Note: Other liabilities comprise small savings raised from the people, state provident funds, reserve funds, treasury bills issued.

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Table-6.6 Financing of gross fiscal deficit of the state governments (in per centage) Sources of financing

1990-91

1995-96

2002-03

2003-04 2004-05 RE BE 1. Loans from central govt. 53.1 47.1 -1.8 -15.1 -6.5 2. Market borrowings 13.6 18.7 27.9 32.1 23.0 3. Other liabilities 33.3 34.2 73.9 83/0 83.6 4. Total (1+2+3) 100 100 100 100 100 Note: Other liabilities comprise small savings raised from the people, state provident funds, reserve funds, deposits and advances, and loans from Financial Institutions. With the change in the system of accounting with effect from 1999-2000, state share in small savings, which were hitherto included under loans from the central government, is included under other liabilities.

(c) Contingent liabilities of the government In 1990s there was a steady decline of the contingent liabilities of the central government, but an increase in the liabilities of the states (Table-6.7). Many states have now initiated measures to contain the growth of guarantees such as discretion and selectivity for the provision of guarantees, disclosing comprehensive information in budget documents, setting up of guarantee redemption funds, fixing statutory and administrative limits on guarantees and charging guarantee commissions on outstanding guaranteed amounts. A Group to Assess the Fiscal Risk of State Government Guarantees (2002) made the following suggestions to contain state guarantees and fiscal risk: • Guarantees to be met out of budgetary resources should be identified and treated as equivalent to debt. • For other guarantees, projects and associated costs need to be identified.. • Guarantees need to be mapped for future devolvement. • Data need to be published for generating public debate. • A State level centralized unit should be set up to track and monitor guarantees. • At least one per cent of outstanding guarantees to be transferred to the Guarantee Redemption Fund every year. Table 6.7 Outstanding Government Guarantees (as per centage of GDP) Year 1992-93 1993-94 1994-95 1995-96 1996-97 1997-98 1998-99 1999-2000 2000-01 2001-02 2002-03

Centre 7.8 7.3 6.2 5.5 5.1 4.9 4.3 4.3 4.1 4.2 3.7

States 5.7 5.7 4.8 4.4 4.6 4.8 5.6 6.8 8.1 7.2 7.5

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Total 13.4 13.0 11.0 9.9 9.7 9.7 9.9 11.2 12.2 11.4 11.2

(d) Public Debt The high level of fiscal deficit of the Central Government has led to steady accumulation of debt by the Central Government, as indicated by rise in debt-GDP ratio from 92 per cent (comprising domestic debt at 82 per cent and external debt at 9 per cent) at the end of March 2002 to 97 per cent (comprising domestic debt at 88 per cent and external debt at 8 per cent) at the end of March 2004 (Table 6.8). The debt-GDP ratio of the Central government is estimated to be 66 per cent (comprising domestic debt at 60 per cent and external debt at 6 per cent) at the end of March 2005. Table-6.8 Domestic Debt of the centre and state combined at end March Items

2000

2001

2002

2003

2004

2005

Domestic debt combined (Rs.billion)

13827

16007

18815

21857

24828

28420

Centre

9626

11026

12949

14996

16771

19311

State

4201

4981

5867

6861

8057

9109

2044

2052

2130

2019

1834

1735

2044

2052

2130

2019

1834

1735

0

0

0

0

0

0

15871

18059

20946

23876

26662

30155

Centre

11670

13078

15079

17015

18605

21046

State

4201

4981

5867

6861

8057

9109

External debt combined (Rs.billion) Centre State Total govt. debt combined (Rs.billion)

Domestic debt as % of GDP (combined)

71.4

76.6

82.4

88.5

88.3

89.6

Centre

49.7

52.8

56.7

60.7

59.6

60.9

State

21.7

23.8

25.7

27.8

28.6

28.7

External debt as % of GDP (combined)

10.6

9.8

9.3

8.2

6.5

5.5

Centre

10.6

9.8

9.3

8.2

6.5

5.5

State

0.0

0.0

0.0

0.0

0.0

0.0

81.9

86.4

91.8

96.7

94.8

95.1

60.3

62.6

66.1

68.9

66.2

66.3

Total govt.debt as % of GDP (comb) Centre State

21.7

23.8

25.7

27.8

28.6

28.7

1105

1247

1424

1584

1800

1917

Centre

902

993

1075

1178

1246

1295

State

202

254

349

406

554

622

Interest payments combined (Rs.billion)

Revenue receipts combined (Rs.billion)

3437

3788

4002

4505

5292

6054

Centre

1815

1926

2014

2317

2630

3093

State

1623

1862

1987

2187

2662

2961

5.7

6.0

6.2

6.4

6.4

6.0

4.7

4.8

4.7

4.8

4.4

4.1

Interest payment as % GDP Centre State

1.0

1.2

1.5

1.6

2.0

2.0

32.1

32.9

35.6

35.2

34.0

31.7

Centre

49.7

51.6

53.3

50.8

47.4

41.9

State

12.5

13.6

17.6

18.6

20.8

21.0

Interest payment as % revenue

Notes: (1) States are not allowed to borrow directly from external sources. Centre government borrows externally on behalf of the state governments and lends it to the state governments as domestic debt. Therefore, all external debt is shown on the central government account. (2) General government public debt may not add up to the respective public debt of the Centre and States on account of inter-government transfers.

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The combined domestic debt of the general government is expected to increase from 88 per cent of GDP in 2003 (comprising domestic debt of the centre at 60 per cent and state government debt at 29 per cent) to 90 per cent in 2004 (comprising central government domestic debt at 61 per cent and state government debt at 29 per cent) (Table-6.8). The combined public debt stock (comprising both internal and external debt) of the general government (comprising central government and state governments) is expected to remain at 95 per cent of GDP (comprising central government debt at 66 per cent and state government debt at 29 per cent) at the end of March 2005 (Table-6.8). A high overhang of domestic debt poses significant challenges for debt management as it puts pressure on interest rates, crowds out private investment and creates problems for future debt servicing. In order to avoid the problem of bunching of redemption and rollovers, the central government is concentrating on medium term and long term borrowings. The weighted average maturity of market loans in 2002-2004 increased to 13.5 years from 7.7 years in 1998. Nevertheless, the overall maturity of the marketable debt remained skewed towards the shorter and medium end of the market. 7. Money and Finance (a) Monetary policies Broad money supply (M3) increased by 16.6 per cent in 2003 compared with an expansion by 14.7 per cent in 2002 mainly due to higher growth of aggregate deposits of the scheduled commercial banks (16.6 per cent in 2003 compared with 12.7 per cent in 2002) and substantial growth of net foreign exchange assets by 33.7 per cent in 2003 compared with 26.6 per cent in 2002. The basic objective of monetary policies announced by RBI in 2004 was to contain inflation around 5 per cent and to sustain overall GDP growth rate in the range of 6.5 to 7 per cent. In the face of a distinct acceleration of the inflation rate, the thrust of the monetary policy in 2004 was to check liquidity but to ensure adequate flow of credits to the productive sectors of the economy and to support revival of investment demand. Inflation target was later revised upwards to 6.5 per cent. As per the monetary and credit policy announced in May 2004, the cash reserve ratio (CRR) was kept unchanged at 4.5 per cent, the bank rate at 6 per cent and the repo rate at 4.5 per cent. Banks were advised to put in place comprehensive and rigorous risk assessment methods. Other policies announced included the following:      

Micro finance institutions would not be permitted to accept public deposits until they comply with extant regulatory framework of the RBI. Development of mechanism for debt restructuring of medium enterprises. Scope of infrastructure was widened. A Gold card scheme was introduced for exporters. ECB limit was enhanced to $500 million under automatic route. Resident individuals are permitted to remit freely up to $25, 000.

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    

Indian corporate and partnership firms were allowed investing overseas up to 100 per cent of their net worth. Banks were allowed to raise long term bonds for financing infrastructure. Banks to draw a road map for movement towards Bassel-II by December 31, 2004. Banks to make higher provisioning for older NPAs. Risk based supervision is extended to more banks.

The mid-year monetary policy announced by the RBI in October 2004 did not change the bank rate, but increased CRR and repo rate. To discourage inflationary expectations, RBI announced upward revision of cash reserve ratio (CRR) by 50 basis points on September 11, 2004 to be effected in two stages, and a hike in the repo rate by 25 basis points to 4.75 per cent. The RBI refrained from enhancing the lending rates, despite speculations to the contrary, because of its perception, also shared by the Government, that the inflationary pressure starting with mid-May 2004, is commodity price driven rather than the result of excess liquidity, Therefore, any attempt to increase the interest rate to curb the liquidity would be counter-productive, as it would adversely affect investment and growth, thereby reinforcing the inflationary pressures. In 2004 there was strong growth in bank deposits despite low real interest rates, particularly longer-term rates. There was abundant liquidity in the system and low offtake of commercial credits. There was a substantial increase of investments by commercial banks in government securities and bonds. As on the 15th October 2004, the annual growth of the broad money supply was 14.5 per cent supported by an increase of net bank credit to the government by 5.1 per cent, bank credits to the commercial sector by 23.5 per cent, net foreign exchange assets by 30.8 per cent and government’s currency liabilities to the public by 1.5 per cent. Total bank credits of the commercial banks increased by 28.8 per cent aided by a substantial increase of both food and non-food credits. Aggregate deposits of the banks increased by 15.9 per cent, while investments by the banks in government securities declined significantly. . Composition of bank credits by industry groups reveals that there was significant increase in credits to tea, jute textiles, sugar, food processing, gems and jewellery, computer software and hardware. On the other hand, there was a decline of credits to cotton textiles, drugs and pharmaceuticals as these sectors had in general surplus funds. Given these trends and expecting real GDP growth rate around 6 per cent and the rate of inflation around 6 per cent in terms of WPI, broad money supply is expected to grow by 14.5 per cent as compared to target at 4 per cent in 2004 for creating a favorable environment for investment.

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(b) Financial sector performance and policies Several measures were announced in 2004 to strengthen the capital market. These measures included the following: • • • • • • • • •

FDI limit raised from 40% to 49% in civil aviation and limits are being raised in insurance and telecommunications. Interest rates on public provident funds and small savings kept unchanged at 8% while introducing a Senior Citizens Deposit Scheme with interest rate of 9%. An Investment Commission and a National Manufacturing Competitiveness Council set up. A Board for Reconstruction of Public Sector Enterprises is established. Fund for Regeneration of Traditional Industries to be set up. Ceiling for loans under the Capital Subsidy Scheme raised for SSIs. Securitisation Act amended to take care of borrower’s interest. Legislation for defined contribution pension scheme is introduced. Bank credits to agriculture are liberalized.

Scheduled commercial banks (SCBs) improved their performance in 2003. The ratio of net profits to total assets improved from 1 per cent in 2002 to 1.2 per cent in 2003. There was also a decrease of net non-performing assets (NPAs) of the commercial banks, which amounted to 3 per cent of net advances at the end of March 2004 compared with 4.5 per cent at the end of March 2003. All commercial banks out of 90 banks with the exception of only two attained the minimum capital adequacy ratio (CAR) of 10 per cent by end March 2004. Stock market remained volatile but bullish in general in major parts of 2003 as a result of sustained industrial growth, bumper agricultural production, substantial build up of foreign exchange reserves, strong Indian rupee, sound macro economic environment and favorable credit rating by all credit rating organizations. BSE Sensitive Index, which maintained an average value of 4492 in the range of 2924-6194 in 2003, started with the average value of 5167. The up trend witnessed in 2003-04 was broad-based and covered almost all the sectors. Indian stock markets outperformed many other emerging markets in Asia. Stock prices had fluctuating trends in 2004 influenced by general elections and political uncertainty in the first quarter followed by acceleration of inflation, delayed monsoon and deficient rainfall, and hardening of international prices of petroleum products, minerals, metals and metal products. However, prices showed upward trends due to sound economic environment, strong rupee, substantial build-up of foreign exchange, sustained industrial growth and moderate fiscal deficit.

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8. Key policy issues (a) Development policies The Tenth five-year Plan (2002-2007) has set a target of 10 per cent for industrial growth and 8 per cent for overall GDP growth. The Plan has highlighted that the overwhelming priority is to speed up second-generation reforms to regain the growth momentum and boost domestic and foreign investment. There is need for greater co-ordination, co-operation and partnership between private and public sectors. Both well-governed state and well functioning markets are essential for high growth and sustainability. Government and free markets should supplement and complement each other. Government should withdraw from sectors where private participation is more productive and more efficient. But the scope of government is to remain large in social sectors and physical infrastructure. Momentum of reform needs to be maintained for sustaining higher growth and rapid progress toward poverty alleviation. In particular, ambitious fiscal consolidation and broad based structural reforms are needed to allow resources to be redirected from servicing public debt towards economic development and social programs and to create enabling environment for private investment. (b) Agriculture Policy Prospects of agricultural production in the current year 2004-05 are not considered to be bright due to erratic monsoon. Agriculture accounts for 20 per cent of the GDP and provides livelihoods to 66 per cent of the country's population. Over the years, the agriculture sector has not received as much attention as other sectors in services and manufacturing. The emerging areas in agriculture like horticulture, floriculture, organic farming, genetic engineering, food processing, branding and packaging and financial derivatives have high potentials of growth. Development of rural infrastructure, rural extension services, agro-based and food processing industries are essential for generating employment and reducing poverty. Indian agriculture suffers from a mis-match between food crops and cash crops, low yields per hectare except for wheat, volatility in production and wide disparities of productivity over regions and crops. Domestic production of pulses and oilseeds are still below the domestic requirements and India imports pulses and edible oils to satisfy domestic demand. India is the second largest producer of rice and wheat in the world, first in pulses production and fourth in coarse grains. A distinct bias in agricultural price support policies in favor of rice and wheat distorted cropping pattern and input usage. Market for farm output continues to be subject to heavy procurement interventions. A shift from minimum support price system and developing alternative product markets are essential for crop diversification and broad based agricultural development.

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In recent years there has been considerable emphasis on the development of horticulture and floriculture through the creation of critical infrastructure for cold storage, refrigerated transportation, processing, packaging and quality control. India is the largest producer of coconut, cashew nuts, ginger, turmeric, and black pepper, and the second largest producer of groundnut, fruits and vegetables. India accounts for 10 per cent of the world fruit production with first rank in the production of bananas, sapota and acid lime. India is also the largest producer of milk, the fifth largest producer of egg and the seventh largest in meat. It is necessary to improve cold storage and transportation facilities and developing efficient marketing and export networks. Food management is inefficient with unsustainable level of food subsidies imposing heavy burden on government finance. The rural economy and the private sector lack the basic infrastructure to build up sufficient buffer stocks, and the country remains vulnerable to weather shocks. In recent years, the central government has provided various fiscal incentives for improving rural storage facilities. The government is also providing financial assistance to the State governments for procurement and distribution of food grains at subsidized rates particularly to the families below the poverty line. The enhanced availability of bank credits through priority lending to agriculture and agro-based industries, favorable terms of trade, liberalized domestic and external trade for agricultural products attracted private investment in agriculture in recent years. It is likely that with the appropriate policy initiatives, this process will accelerate in the future. (c ) Fiscal Policy The government is committed to fiscal consolidation but the results to date are not encouraging. Large revenue and primary deficits with nearly 50 per cent of revenues going toward interest payments on government debt, high and growing amounts of public debt held by financial system, poor physical and social infrastructure, and high levels of poverty are not conducive to sustained high growth. Moreover, such a situation limits the scope for use of fiscal policies to support economic activity, complicates the conduct of monetary policy, and erodes the government's credibility with investors. The government needs to formulate a medium-term strategy to put the fiscal balances on a sustainable path. Fiscal consolidation and debt reduction have to be an integral part of a more comprehensive, coherent and multipronged strategy consisting of tax and expenditure reforms. Revenues need to be raised through broadening of tax base, further rationalization of rate structures, removal of exemptions, continued improvement in tax administration, introduction of a comprehensive Value Added Tax (VAT) and further widening the service tax base. In addition, expenditure needs to be rationalized by reducing subsidies and the wage bill. Disinvestment of government equity in public enterprises needs to be expedited and a part of the privatization receipts is earmarked for pre-payment of more expensive public debt, restructuring weak public enterprises and for high priority social expenditures. The

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effective implementation of the newly enacted Fiscal Responsibility and Budget Management Act would be important as a signal for fiscal reforms. The deteriorating fiscal situation of the states needs to be tackled urgently. Although encouraging steps are being taken in some states (e.g., the passage of fiscal responsibility legislation and measures to curb borrowing and contingent liabilities), much more needs to be done for reversing the sharp deterioration in states' finances. Key steps include accelerating power sector reforms, increasing user charges for public utilities, closely monitoring irrigation projects, restructuring state financial and transport companies, disinvestments of state level PSUs, implementing the VAT, and introducing more stringent ways to prevent the build up of state debt and contingent liabilities. (d)Unfinished Agenda on Reforms Areas where further reforms would promote greater efficiency include the following: (a) Privatization of public enterprises at a faster speed, (b) Liberalization in land and labor markets, (c) Formulation of an effective exit policy for bankrupt firms, (d) Coordinating state level reforms (e) Reforms in local governments (i.e. municipalities and corporations) (f) Strengthening regulatory bodies in infrastructure (g) Reforms in insurance, provident and pension funds, and (h) Thrust on state provision of basic needs. The following structural reforms need to be given priority:  Although major reforms were taken at the macro level and in production sectors, credible reforms need to be taken at local bodies particularly with regard to sale, acquisition and transfer of land and property.  Indian labor is highly protected. Reforms are necessary in labor markets for enhancing employment.  Regaining the momentum of the disinvestment program is critical for fiscal sustainability and improving efficiency in the public sector.  Further liberalization of the non-debt creating financial flows including FDI is required for petroleum, real estate, telecom, civil aviation, banking and insurance. There are synergies between disinvestment and the FDI strategy, and serious consideration may be given to use disinvestment as a magnet for foreign investment.  There is significant scope for increasing Indian exports by encouraging both laborintensive and high technology products.  India will have to face and surmount the challenges posed by new technologies and market places, such as Internet and e-commerce.  It is important to lock in recent gains on the inflation front. Management of inflation and protecting the interest of the vulnerable and weaker sections of the society should remain a priority agenda for the government.  Another priority of the government is to reduce inter-state disparities and interregional inequality.

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Statistical Tables Table-1 Selected Economic Indicators Items

2002

Real GDP growth Agriculture Industry Services Inflation rate (CPI)

4.0 -5.2 6.4 7.1 4.0

(a) GDP growth rates (per cent) 2003 2004 2005 Estimate Forecast 8.1 6.0 6.8 9.1 -2.0 2.0 6.5 7.1 7.3 8.4 8.8 8.5 3.9 5.0 4.0

2006 Forecast 7.2 3.0 7.5 8.5 4.0

2007 Forecast 7.5 4.0 8.0 8.5 4.0

Inflation rate (WPI) 3.5 5.4 6.8 4.0 4.0 4.0 Source: National Accounts Statistics 2004, Central Statistical Organisation (CSO) for 20022003 and author’s estimates/ projections for 2004-2007. (b) Gross Domestic Savings and Investment (in Per cent of GDP at current mp) As per cent of GDP 2001 2002 2003 2004 2007 Estimate Estimate Forecast Gross domestic savings (GDS) 23.5 24.2 25.0 25.0 28.0 26.2 26.0 26.0 25.5 27.0  Private sector -2.7 -1.9 -1.0 -0.5 1.0  Public sector Gross domestic Investment (GDI) 23.1 23.3 23.6 23.7 27.8 17.3 17.6 17.7 17.8 20.8  Private sector 5.8 5.7 5.9 5.9 7.0  Public sector Resource gap = (GDS-GDI) 0.3 0.9 1.4 1.3 0.2 Source: As for Table (a). (c) Fiscal Situation of the Central Government Central government budget 2001 2002 2003 2004 2004 as per cent of GDP Rev.Est. (BE) Est. 6. Tax revenue 5.9 6.5 6.7 7.3 8.1 7. Total non-debt revenue 9.7 10.9 12.2 10.7 11.1 8. Current expenditure 13.2 13.8 12.9 12.1 11.2 9. Total expenditure & net lending 15.9 16.8 16.9 15.0 14.7 10. Overall budget balance (2-4) -6.2 -5.9 -4.7 -4.3 -3.6 Source: Central Government Budget 2004-2005, Ministry of Finance for the years 2001-2004 and author’s estimates for 2004. (d) Finances of Cetre and States combined (as per centage of GDP) Items 2001 2002 2003 2004 Rev.Est. (BE) 1. Gross fiscal balance [Deficit ( -)] 9.9 9.5 9.4 7.9 2. Revenue balance [Deficit ( -)] 7.0 6.6 6.2 4.0 3. Primary balance [Deficit ( -)] 3.7 3.3 2.9 1.7 Source: As for Table (c).

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2004 Est. 9.6 6.2 3.2

(e) Foreign trade

Value in US$ million 2003

Trends of Foreign Trade Value in US$ million 2004 Est.

Growth rate 2002 (Per cent)

Growth rate 2003 (Per cent)

Est. GR 2004 (Per cent)

Merchandised exports 62952 75542 16.9 19.9 20.0 Merchandised imports 79658 96386 13.5 21.8 21.0 Services exports 51939 58635 18.2 19.7 12.9 Services imports 26514 28635 13.4 0.7 8.0 Source: Reserve Bank of India Annual Report 2003-2004, RBI, Mumbai, August 2004 for the years 2002-2003, and author’s estimate for 2004.

(f) Trade and Current Account Balance

Items Merchandised trade balance Net invisible balance Current account balance Net capital inflows Overall balance of payments Source: As for Table (e).

2002 US$ Million -12910 17047 4137 12843 16980

2002 As % Of GDP -2.5 3.3 0.8 2.5 3.3

2003 US$ Million -16706 25425 8719 22703 31421

2003 As % of GDP -2.7 4.2 1.4 3.7 5.1

2004Est US$ Million -20844 30000 9156 10650 19806

2004Est As % of GDP -3.0 4.3 1.3 1.5 2.9

(g) Net Capital inflows (in US$ million) Net capital inflows External assistance, net Foreign direct investment (FDI), net Portfolio investment, net Commercial bank credits, net Other capital inflows, net Total capital inflows, net Official grants Capital inflows including grants Source: As for Table (e).

2001

2002

2003

1117 4741 1951 -1576 4743 10976 384 11360

-2480 3611 944 -2344 13112 12843 410 13253

-2661 3137 11355 -1853 12725 22703 559 23262

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2004 Estimate 1900 3500 1000 850 3700 10950 500 11450

(h) Outstanding External Debt in millions of US dollar

Items

March 2002

March 2003

March 2004

External debt Long term Public Private Short term Debt services In US dollars As % of gross exports As % of GDP

98757 96012 43619 52393 2745

104869 100300 43716 56584 4569

112593 107857 44303 63554 4736

March 2005 Proj. 114507 109507 46103 63404 5000

10863 13.4 2.3

14407 15.1 2.8

20949 18.3 3.4

17000 13.5 2.5

Source: Ministry of Finance and Reserve Bank of India.

(j) Bank deposit and lending rates (in per cent) Items

2001

2002

2003

2004

Bank term deposit rates * Nominal Real

5 to 7.25 1.4 to 3.65

4.25 to 6.5 0.85 to 3.1

4 to 6

4 to 6.25

Bank lending rates* 11 to 12.5 10.75 to 12.0 10.25 to 11 10.50 to 11.50 Nominal 7.6 to 9.1 7.35 to 8.6 Real Bank rate (latest) (RBI Refinance rate for 6.5 6.25 6.0 6.25 the commercial banks) * Nominal deposit rate refers to interest rate on time deposit of 12 months and above. Nominal lending rate is the prime lending rate (PLR) on short or medium term borrowings by the private sector.

(i) Stock Exchange Indices Stock exchange index

2002

2003

2004 Q1

2004 Q2

2004 Q3

2004 Q4

Bombay Stock Index (BSE) Sensitive Index Base: 1978-79 = 100 Average 3206 4492 5167 5300 5640 High 3513 6194 5926 5617 5843 Low 2834 2924 4505 4848 5641 S&P CNX Nifty* Base: 1995= 100 Average 1037 1428 1331 1622 1795 High 1147 1982 1892 1754 1837 Low 923 924 1389 1523 1780 • NSE-50 i.e. Nifty has been rechristened as “S&P CNX Nifty” with effect from July 28, 1998. Sources: 1. The Stock Exchange, Mumbai. 2. National Stock Exchange of India Lt.

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