India - Structural change and development perspectives (Vol. 3 of 3)

Document of The World Bank FOR OFFICIAL USE ONLY Report No. 5593-IN INDIA: STRUCTURAL CHANGE AND DEVELOPMENT PERSPECTIVES Supporting Working Papers April 24, 1985 South Asia Programs India Division This document has a restricted distributies amd may be used by recipients enly in the performmace of their offcial dulles. Its contents may not otherwise be disclosed without Wodd Bank authoriztion. CURRENCY AND OTHER EQUIVALENTS Currency Prior to June 6, 1966: US$1.00 = Rs 4.7619 Rs 1.00 = US$0.21 From June 6, 1966 to mid-December 1971: US$1.00 = Rs 7.50 Rs 1.00 = US$0.13333 Mid-December 1971 to end-June 1972: US$1.00 = Rs 7.27927 Rs 1.00 = US$O.1374 After end-June 1972: floating rate Rate end-March 1985: - US$1.00 = Rs 12.3457 Rs 1.00 = 0.0810 Rupee values have been converted into dollars by using the prevailing exchange rates indicated above up to 1970/71. For subsequent years the following average rates in rupees per US dollar have been used: 1971/72 : 7.444 1975/76 : 8.653 1979/80 : 8.076 1972/73 : 7.706 1976/77 : 8.939 1980/81 : 7.893 1973/74 : 7.791 1977/78 : 8.563 1981/82 : 8.929 1974/75 : 7.976 1978/79 : 8.206 1982/83 : 9.628 1983/84 : 10.312 Source: IMF, International Financial Statistics (IFS), line "rf." In this report an estimate of 11.9 Rupees per US Dollar was used for 1984/85. Weights Unless ozherwise specified all weight measures are metric. Years The Indian fiscal year runs from April 1 through March 31. FOR OFFICIAL USE ONLY INDIA: STRUCTURAL CHANGE AND DEVELOPMENT PERSPECTIVES WORKING PAPERS I - VII Pase No. I. GROWTH AND STRUCTURAL ADJUSTMENT 1 II. RESOURCE MOBILIZATION AND PUBLIC EXPENDITURES 45 III. FOREIGN TRADE - TRENDS AND POLICIES 83 IV. AGRICULTURE, FOOD, AND POVERTY 94 V. DEVELOPHENTS IN ENERGY 131 VI. MANUFACTURING INDUSTRY, ETERNAL ADJUSTMENT AND STRUCTURAL CHANGE, 1973 - 1983 163 VII. REVIEW OF INDUSTRIAL LICENSING POLICY (1951-1985) 199 This document has a reutriced distribution and may be used by recipients only in the perforance of their official dmties. Its ctents may not otherwise be disrosed without World Bank authorization. WORKING PAPER I GROWTH AND STRUCTURAL ADJUSTMENT Prepared by John R. Hansen with contributions from Willem C.F. Bussink -2- WORKING PAPER I GROWTH AND STRUCTURAL ADJUSTMENT Page No. A. Introduction ...................................... 3 B. Historical and Annlytical Background ......................... 4 C. Shocks and Adjustments, 1973/74 - 1983/84 6 First Shock - 1973/74 ........................ ................ 7 Second Shock - 1978/79 ........................ ... ......... 9 D. Savings-Investment Balances ................... ............ 10 E. Speed and Structure of Growth .................... 13 F. Efficiency of Capital Use .................................... 18 Tables 1.1 Savings and Investments (Z of GNP) - Two-Year Averages 11 1.2 Changes in Production and Price Structure .............. 15 1.3 Gross/Net Incremental Capital/Output Ratios ........... 20 IA Incremental Capital/Output Ratios, 1973/74 - 1982/83 ....... 21 1.5 Selected Public Sector and Economy-Wide Incremental Capital/Output Ratios ....................... .......... 22 I.6 Inr-emental Capital/Output Ratios in World Market Economies at 1975 Prices ...... . ......... .. ... ......... 26 Figures 1.1 Shocks Analysis, 1973/74 - 1983/84 ......................... 8 1.2 Cross Domestic Product, 1969/70 - 1983/84 ................. 14 1.3 Incremental Capital/Output Ratios ........................... 19 Attachment A: Shocks/Adjustment Analysis - Detailed Results ..... 27 Table IA.1 Price Indices in US dollars ............ 33 Attachment B: Notes on Methodology ................... .....oo...o.. 37 Attachment C: Data Documentation ............................. 39 Table I.C.1: Structural Adjustment Analysis - Decomposition, 1973/74 - 1983/84 (percentages) ................... 40 Table I.C.2: Structural Adjustment Analysis - Decomposition, 1973/74 - 1983/84 (US$ million) ................... 41 Table I.C.3: Shocks/Adjustment Analysis - Details, 1973/74 - 1983/84 ................................. 42 Table I.C.4: Shocks/Adjustment Analysis ........................ 43 -3- WORKINC PAPER I 11 GROWTH AND STRUCTURAL ADJUSTMENT A. Introduction 1. India has grown more rapidly in the past 10 years than in the pre- vious decade. This is in sharp contrast to the experience of most developing and many developed countries which, during the same 10 years, were seriously affected by the oil shocks and related events. This Working Paper examines the various positive and negative factors which affected India's external payments position between 1974 and 1984. It then looks at the ways in which India e..juzsted to these shocks - i.e. the ways in which it restored a sus- tainable current account deficit. Although it is unlikely that India will face similar external shocks during the coming decade, India's experience with making substantial changes in its economic structure in response to changed realities provides lessons in economic management that could be useful (a) as India seeks to make further changes in pursuit of goals such as modernization and poverty alleviation, and (b) in the event of other major economic shocks, including for example internal shocks such as a series of bad monsoons. 2. With two major oil price shocks, large commodity price fluctuations, stagflation in the major OECD countries, and exceptionally high real interest rates in the latter part of the period, the past 10 years have been a period of major disruptions and changes for the world economy. In response to these shocks, the developing (and many developed) countries had to undertake major efforts in export promotion, import substitution, and domestic demand manage- ment to restore a sustainable external payments position. Such structural adjustments take time, and oil importing countries therefore were forced, at least initially, to borrow substantial amounts from abroad to finance their payments gap. For developing countries in general, the domestic structural adjustments needed to accommodate the external shocks were often painful and involved considerable sacrifice. When adjustments were unduly postponed or not undertaken at all, countries subsequently faced major interruptions of their development process. 3. India, however, came through the difficult decade 1973-83 without major economic disruptions. This was partly the result of development policies that had been initiated in the late sixties in response to the exigencies of that period, particularly the high level of imported foodgrains, the generally heavy dependence on external capital flows, and the resultant debt obligations. At the time of the first oil shock in 1973, India was therefore on a generally solid path and had reduced its current 1/ This Working Paper, together with six others, supports the analysis in Chapter 2 of the Report, India: Structural Change and Development Perspectives, Report No. 5593-IN, dated April 24, 1985. -4- account deficit to minimal levels through import substitution and export growth. Thus, the basis had been laid upon which, with special efforts in selected areas, India could adjust to the external shocks while still main- taining a commendable rate of domestic growth. Aside from a bad drought year in 1979/80, India has been sustaining some of its highest-ever five year growth trends. The decade following the first oil shock is therefore essen- tially a success story. 4. The story is not finished, however. Despite the successes of policies during the past decade, the balance of payments outlook is clouded by uncertainties about export performance, and basic problems remain of population pressure, poverty, scarcity of resources, and efficiency of their use. Under such circumstances it is important to consider what lessons can be learned from the experience of the past decade to further accelerate Indist's economic development. This note provides an over-view of the external shocis which India experienced during the past decade, and the ways in which it hats adjusted. The analysis is presented in terms of two major sub- periods -- (a) the time from the first major increase in the world price of oil in 1973/74 to the second major increase in 1979, and (b) the period since 1979.. 5. Although external shocks were a significant factor in the pattern of India's development over the past decade, in a large counLi iike India where foreign trade is relatively small compared to total domestic economic activrity, 1/ they in no way account for all of the critical forces at play during this period. This Working Paper therefore does not pretend to present a conplete picture of India's development process over the period. It focuties primarily on the analysis of external shocks and adjustments during the decade after the first oil shocks, but India's problem has been and continues to be mainly one of growth rather than adjustment to external shocks. This note should therefore be read in conjunction with the other sections of this report which focus on internal issues such as growth in industry and agriculture, the development of indigenous energy resources, and domestic resource mobilization. B. Historical and Analytical Background 6. As noted above, India was already involved in a process of structural adjustment by the time of the 1973/74 oil crisis. In contrast to current account deficits of 4.2% and 1.9% of GDP in 1965/66 and 1968/69 respectively, 1/ In 1982, for example, Indian exports of goode and non-factor services were equivalent to only 6% of GDP, compared to averages of 11% for other low income countries, 23% for middle income countries, 10% for China and 9% for the USA. -5- the current account was in balance in 1973/73.1/ The adjustments during the 60s and early 70s were not without cost however. To restore a sustainable external payments position, India had severely constrained the growth of imports. Although the level of imports varied from year to year, trend analysis indicates an essentially zero import growth in real terms over the period, and thus a zero elasticity with respect to GDP. While an analysis of the consequences is outside the scope of this report, it is likely that one of the costs of this very limited import availability was to contribute to India's less than satisfactory growth of about 3.5% per annum during this period. 7. These developments in the 60s have a direct bearing on the analysis of the 70s, for they must be considered when judging what might have happened had there not been the oil shocks of 1973/74 and 1979/80. If imports had continued to stagnate while exports grew according to earlier trends (i.e. about 4% per annum, which was substantially less than growth of world demand), a rapidly increasing current account surplus would have materialized. This would obviously have been highly undesirable, and policies would almost certainly have changed so as to absorb, at a minimum, India's own foreign exchange resources. It is assumed here that this would have resulted in an expansion of imports at least roughly in line with GDP growth (elasticity of one). Such import growth, and continuation of other trends, would have led to more rapid growth as well as a sustainable current account deficit. 8. A brief explanation is needed at this point regarding the shocks/adjustment accounting methodology used in this paper. Shocks (such as world oil price increases) over which the Government had no control, and adjustments (such as import substitution) which the Government can influence through its policies, are measured as the deviation between what actually happened and what might have happened had there been no oil shocks, or no policy adjustments. The analysis thus depends on the assumptions made about what would have been. With a few exceptions as noted below, these are generally based on continuation of earlier trends. While the specific "what if" or counter factual assumptions made in this report can of course be questioned, they, in the judgement of the authors, provide a reasonable basis on which the impact of the oil shocks and adjustments can be evaluated. Other economists have done similar analytical work, not only for India, but for other countries as well. 2/ The approach followed here and the results obtained are generally similar to those of others, and in order to contrast India's experience to that of other countries, the results of some of these 1/ A balanced current account is of course not necessarily a good thing, especially for a developing country which can make good use of resources (foreign savings) from abroad. 2/ These include Ahluvalia, Bacha, Balassa, McCarthy, Mitra, and others. For full references, see Attachment B, which also provides more detailed comments on the methodology used here. -6- studies have been used as indicators of comparative directions of change and orders of magnitude. 1/ 9. In the following discussion, the shocks and adjustments for each year are given as percentages of that year's current price GDP, and the entry for each component indicates the difference between the actual and the hypotheti- cal (counter factual) value for the component in that year. As shown in Figure I.1 these values start at zero in 1973/74, the base year for the analysis, 2/ and thereafter become smaller (larger) as the actual and hypothetical values move closer (farther) apart. The sign of each component indicates a positive or negative impact on the balance of payments. The percentage value for any specific year does not indicate the "new" shock or adjustment that took place in that year, but rather the difference between the actual and hypothetical value in that year. Incremental shocks and adjustments may be calculated by looking at the differences in value of adjoining years. (As the percent of GDP values shown in Figure I.1 reflect both absolute changes in the shock/adjustment component and changes in CDP, the reader may wish to refer to Attachment C where the absolute values in US$ are given). C. Shocks and Adjustments, 1973/74 - 1983/84 31 10. The large petroleum price increases and their aftermath have affected the Indian economy in three main ways. First, import prices rose sharply, an effect partly compensated by higher export prices. Second, world economic growth and trade suffered a slowdown which influenced demand for Indian exports. Third, greatly increased activity and demand for labor in -he oil producing Middle-Eastern countries led to significant migration of labor from India and to a very large jump in remittances from workers. Other shocks such as interest rate changes that were important to other countries had a relatively minor effect on India. (In fact, India had a very strong reserves 1/ For the period after the first oil shock, the primary source of com- parative data on the experience of other primary producing LDCs is the World Development Report 1981, p. 66, which in turn is based on the work of Balassa, Mitra and others. For the period after the second oil shock, there is not yet any analysis on a sufficiently similar basis to allow meaningful quantitative comparisons. 2/ The values for 1973/74 used as the basis for this analysis have been modified slightly to remove the US$400 million of additional cost of oil imports (due to price increase) uhich occurred in the last few months of India's fiscal year 1973/74; otherwise it was a normal year that serves as a good base year for analytical purposes. 3/ This is a summary of the more detailed analysis of shocks and adjust- ments that is presented in Attachment A. -7- position in the mid-70s and profited from higher interest rates on these reserves). 11. On the adjustment side, there were similarly three main factors which significantly affected India's bilance of payments on current account. First, India increased its exports of goods and non-factor services, attain- ing export growth rates in excess of what might have been expected on the basis of actual export demand and earlier Indian export performance. Second, India reduced certain imports below what otherwise might have been expected given its growth rate. Import substitution in petroleum and foodgrains have been particularly important in recent years. These effects were largely offset, however, by accelerated imports relative to CDP growth in other areas. Third, in many other countries, growth deceleration was found in the last resort to be the only way to restore available balance of payments position. However, in India, the success of its various adjustment measures combined with external developments (especislly a rapid rise in worker's remittances) which led to au unexpectedly good balance of payments position in the mid 70s, made it feasible for India to Liberalize imports and to accelerate is rate of economic growth. In addition to the above factors, which affected the current account of the balare of payments, the interna- tional community reacted to the jump in India's import financing requirement by rapidly increasing grant assistance. The remaining financial needs were met through borrowing. In this connection it should be noted that one of the reasons that India survived the external shocks of the 70s so well is that, in addition to the relatively small share of external trade in overall GDP, India had very little external debt on floating rate terms. Thus its real interest rate burden did not explode as it did for many developing countries. First Shock - 1973/74 12. As can be seen in Figure 1.1, the first oil shock, while severe, faded away quickly for India. Throughout, the size of the shock was largely determined by the terms of trade effect (export/import prices), with the much smaller negative export demand effect being balanced and later more than offset by higher remittances. At its peak in 1975/76, the net shock accounted for nearly 50% of exports, and was therefore very severe in its impact on the balance of payments. As compared to CDP, the peak loss was 2.5%. On average, for the five year period after the first oil shock, the net shock amounted to about 1.4% of GDP, compared to around 3.5% for primary producing LDCs. 1/ By 1977/78, the combined effects of rapidly growing export prices, falling import prices (in dollar terms) and sharply rising demand for workers in the Gulf States (which resulted in a rapid increase in workers' remittances and other transfers) had brought the shock back to a level equivalent to about 0.8% of GDP. This fortuitous development was 1/ World Development Report 1981 p. 66. All period averages given here for India are simple averages of the annual figures. -8- Figure 1.1 INDIA Shocks AnIVSis. 1973/74 - 1983/84 (percent of cuffent GDP) 5.0- 3.0- 1.0.--.. .....mE~% Onco... 1 - -mE-ort Total Shcs -30- -5.n l l l l l l l I 74 75 7C 77 78 79 80 81 82 83 84 FiscoI Years INDIA Adjustrent Analysis. 1973/74 - 1983/84 (percent of cuffent GDP) TOT Adustmens 2.5 Eort (g+nre) 0.5- - .... llC?Subtn o.5 - ''P '**• 0.0c-pslowdown • . _-1.f I I I I I I I I I 74 75 76 77 78 79 80 81 82 83 84 Fascal Years INDIA Shocks/Adjustmenis Analysis. 1973/74 - 1983/84 b . (percent of current GDP) 4.0- 2.0- d..- ^,"TOT Adjustments _20 -o ··*«......------... 74 75 7o 77 78 79 80 81 82 83 84 Fisco Yars WorldBonk-27354 -9- largely unexpected. In the meantime India had mounted successful efforts at export expansion and import substitution. Through a mix of policies, includ- ing active measures to reduce domestic i.ftation (which in turn led to a depreciation of the real effective exchange rate rhat helped make exDortiag relatively more attractive to producers), other direct export incentives, and domestic demand management, India had managed to increase its exports by 1976/77 to 7.6% of GDP compared to 4.6% in 1972/73. 1/ The import substitu- tion adjustment after the first oil shock averaged about two-thirds of the export adjustment effort relative to GDP and helped to keep imports at about the same level in volume terms as tey had been in the decade 1963-73. Within this constrained total, the normal effect of higher GDP growth on imports was absorbed. One particularly important commodity in which there was strong import substitution (as a result of programs instituted much earlier) was foodgrains. In contrast, edible oil imports increased very rapidly. 13. The net effect of these developments was a significant and totally unplanncd surplus on current account in 1976/77 and 1977/78, which was fur- ther enhanced by increased grants and concessional aid inflows. In a sense these surpluses were akin to those which would have occurred from 1973 onwards had the oil shock not intervened. At least in part as a result of this, the Government started Liberalizing imports. The effect can be seen in the sharp fall in the import substitution adjustment after 1976/77. As a result of this action, the current account surplus was already declining when the second oil shock occurred. Second Shock - 197a/79 14. The second oil shock was not as severe in incremental terms as the first, but it has had a sustained negative impact over a longer period and at a higher level than the first. The continuing international recession resulted (in dollar terms) in falling prices for exports, falling net factor service incomes (including transfers), and slack demand for India's exports abroad. There was also a stagnation in the country's export effort, and perhaps most significantly, a rise in the volume of imports relative to GDP, which helped to sustain if not further accelerate economic growth. Consequently, importa of goods and non-factor services in 1980/81 prices rose from 8.7% of GDP in 1976/77 to over 10% of GDP in more recent years. 2/ This 1/ The exchange rate is discussed in more detail in the Working Paper dealing with balance of payments issues (Working Paper III), while the various fiscal incentives are mentioned further in Working Paper II on public finance. 2/ In current pricee, imports of course increased much more sharply, from about 4.5% of GDP in the early seventies to around 7.5% in the mid- seventies and over 10% in the early eighties. -10- is all the more significant since it occurred despite the substantial import substitution that took place, from 1981/82 onwards, through the very success- ful program for domestic crude oil production. As a result of liberalizing imports, however, the level of the overall adjustment effort, which had reached mre than 3% of GDP in 1976/77, fall back to 0.7% in 1980/81. It recovered to about 2% of GDP thereafter. 11 Thus the effect of the external shocks, which continued at over 3% of GDP after 1981/82, remained only partly compensated by adjustment efforts. Continued foreign borrowing was therefore needed and this perforce took place on much less concessional terms than after the first oil shock. Unlike many developing countries, however, India had sufficient borrowing capacity. Its debt service burden had fallen from 31% of exports in 1970/71 to 7% in 1980/81 as a result of India's successful export effort in the mid-seventies and the effects of international inflation on the real value of India's stock of debt. Given the recent and continuing reduction of average concessionality in available external resources it is clear that the Government will have to continue to monitor carefully its external debt position and its debt servicing capacity so as to maximize the benefits of external borrowing without jeopardizing the nation's currently good creditworthiness. It will also need to ensure that macro-eccnomic policies are in place, along with project-specific safeguards, to maximize the efficiency with which the borrowed (and other) resources are used. Among other advantages, this stress on efficiency will help assure that the resour- ces are used for export production or efficient import substitution and thus that the foreign exchange resources needed to repay the loans will be generated. D. Savings-Investment Balances 15. The external shocks and adjustments described above obviously did not take place in a vacuum; they were intimately connected with domestic developments. More specifically, balance of payments shifts by definition mirrored changes in savings-investment balances. The shifts in these savings-investment balances over the decade -- from 1.5% of GNP to +0.8% and back - cannot be decomposed into shocks and adjustments in the same way as was done above for the external account. However, they can be broken down into changes in investment and savings rates by private and public sectors, and this throws an important light from another angle on the adjustment process and on the adjustment policies -ehich were followed. While the pic- ture as shown in Table I.1 is fairly complex, a few main trends can be perceived. 1/ Import liberalization was one of the rost important steps which the Government took towards structural adjustment of the economy during this period; thus the fact that this resulttd in a "fall" in the "adjustment effort" in terms of the shocks/adjustment decomposition model is not to be taken in any sense as a criticism of these policies. -11- Table I.1: SAVINGS AND INVESTMENTS (% OF GNP) - TWO YEAR AVERAGES 1972-73- 1974175- 1976/77- 1978179- 1980/81 1982/83 1973/74 1975/76 1977/78 1979/80 1981/82 1983/84 Gross National Savings Households 13.2 13.3 15.9 17.3 16.3 16.4 Private Corporate Sector 1.7 1.7 1.4 1.9 1.9 1.8 Public Sector 3.0 4.2 5.0 4.7 4.3 4.6 Total 17.9 19.2 22.3 23.9 22.5 22.8 Foreign Savings (Current 0.4 1.5 -0.8 - 1.9 1.6 Account Deficit) Total Available Savings 18.3 20.7 21.5 23.9 24.4 24.4 Statistical Discrepancy 0.4 0.9 - - 0.1 0.1 Gross Capital Formation 18.7 21.6 21.5 23.9 24.5 24.5 of which: Change in Stocks 2.5 4.8 2.3 4.6 4.7 3.5 Fixed Capital Formation: Private 9.0 10.0 10.5 10.4 10.3 10.2 Public 7.2 6.9 8.7 8.9 9.5 10.8 Memo Items Private Consumption 73.3 73.0 68.7 68.9 68.6 67.3 Public Consumption 9.3 9.4 9.9 9.9 10.1 10.7 Gross Capital Formation 19.6 20.7 20.4 21.8 21.5 20.3 (constant prices) 16. The key indicator in Table I.1 is the balance of payments current account deficit, also defined as the supply of foreign savings to the economy (line 5). It swung from a limited deficit in the base period to a sizable one in the years of the maximum effect of the first oil shock, then to a surplus in the years of maximum adjustment. This was followed by gradual absorption of excess resources at the end of the first shock period, a sizable new deficit after the second shock and only a gradual reduction afterwards. 1/ 17. What stands out immediately from Table I.1 is that India did not accomplish its adjustment by curtailing investment (and thus the demand for imported investment and intermediate goods). The improvement in the balance of payments of 1.2% of GNP between the base period and the maximum adjustment in 1976/77 - 1977/78 was accompanied by an increase in the investment rate by nearly three percentage points. Subsequently, the investment rate continued 1/ To keep Table I.1 manageable and to even out irrelevant annual fluctuations, the data are presented in six two-year periods. Even this limited smoothing blurs some important developments within the periods; these are referred to in the text. -12- to increase rapidly, until it flattened out in the 1980s. Over the whole period, investment in fixed assets increased from about 16Z to 21Z of GNP. Initially, the private sector contributed to the increase, but after a brief setback during the fist oil shock period the public sector accounted for most of the increase, and is fixed investment level for the fist time surpassed that of the private sector by the end of the 10 years. The main development on the investment side is therefore the increase in the public investment rate. The increase is however largely a financial rather than a real phenomenon; prices of investment goods increased considerably faster than the general price level (as measured by the GDP deflator). Thus, in real terms, the overall investment rate increased only by a little over two percentage points at its maximum, then fell back again by 1.5 percentage points. The real investment spurt was therefore much more limited and temporary than the nominal rates suggest. The rise in the relative prices of investment goods was mainly related to relative increases in the prices of basic raw materials for investment, including steel and cement. 18. Still, the nominal increase in the investment rate had to be financed and this, together with balance of payments adjustment, had to be accomplished through -. increase in national savings. In fact, the national savings rate increased extremely rapidly between the base period and the end of the seventies-by 6 percentage points of GNP, bat fell back about a point by the end of the review period. The brief peak. mainly in 1978/79, was accounted for by the private sector. The pattern for the rest of the indicators for both private and public sectors was largely the same: a rapid increase during the first oil shock period, and stabilization during the second. 19. Government policy played a lar6e role in the creation and mobi- lization of additional savings during the first oil shock period. A variety of resource mobilization and demand management measures were taken, both to improve the balance between national resources and expenditures, and to combat inflation, which had accelerated sharply from 1972/73 onwards, follow- ing two years of mediocre harvest and rapid international price increases. The main policy instruments were budgetary and monetary. Among the specific measures were the freezing of all wage increases and half of the additional cost of living increases in the public sector, limitation on dividend dis- tributions by companies, and a scheme of compulsory frozen deposits on the basis of graduated brackets for all income tax payers. Excise duties were increased, a tax was imposed on the interest income of commercial banks (to be passed on in the form of higher lending rates), and railway freight fares were raised. Domestic petroleum prices were raised, interest rates were increased, and the growth of monetary aggregates curtailed. This policy package had a significant impact. Between the base period and the years of maximum adjustment, public sector disposable income increased by 2.7% of GNP. By spending only a limited part of that, the public sector increased its savings by 2.0% of GNP. With the public sector increasing its claim on national resources, the share of private disposable income in GNP declined. Out of this lower income the private sector's savings ratio still increased -13- (some of this increase was involuntary through the schemes mentioned above). This implied a significant squeeze on private consumption; in fact, in all the years up to and including 1976/77, real per capita consumption was no higher than it had been on average, in the first three years of the decade. After that, however, private consumption as a share of GNP showed no further downward trend, and it grew at an average rate of 2% per capita per annum. Finally, with regard to private savings, the important point can be made that "forced savings" through inflation do not seem to have played a role in the fluctuations in private saving activity: rather, the largest increases in savings rates occurred in the years of price stability: 1975/76, 1976/77, and 1978/79, with, presumably, higher savings and lower inflation mutually supporting each other. E. Speed and Structure of Growth 20. Though conclusions partly depend on choice of period and method of computation India appears to have been able to accelerate its growth rate during the past 10 years despite very adverse external conditions. As long as there remain substantial fluctuations in agricultural production, (largely weather induced) and given the repercussions of these fluctuations throughout the economy, overall GDP growth rates will fluctuate. Growth interruptions are bound to recur, especially when there are two or more bad monsoons in a row. This most recently occurred in the early seventies, and growth between the 3-year average periods of 1970/71-72/73 and 1980/81-82/83 was only 3.7% per annum However, if one moves the base period forward two or more years, the economy consistently shows growth rates of 4-4.5% per annum, as compared to 3.71 in the decade of the sixties. Since the terminal period (1980/81-1982/83) includes the drought year 1982/83, and is therefore not unduly biased upwards, it appears reasonable to conclude that indeed over the last decade there has been a perceptible acceleration in the growth rate away from the past average rate of growth of about 3.5% per annum (ref. Figure 1.2). Figure 1.2 INDIA GToss Dornastic Product, 1969/70 - 1983/84 (Index at centered 3-year avmrages, 1973/74=100) 180 - 160 - 140- 120 - tegend:4 100 - - - •- -c -mm Gm D^ti Produet ,..••• - -- -. Secondory es** •••••••••• Terliory 80 70 71 72 73 74 75 76 77 78 79 80 81 82 83 84 Fiscal Years Wodd Bck-27359 -15- Table 1.2: CHANGES IN PRODUCTION AND PRICE STRUCTURE Value Added Price Indices Production Indices of Value Added Z of Current (1970/71 = 100) (1970/71 - 100) Price GDP 1973/74 1978/179 1983/84 1973/74 1978/79 1983/84 1973/74 1983/84 Primary Sector 101 120 130 152 163 294 50.8 39.4 Agriculture 100 120 130 154 159 274 48.1 34.3 Mining & Quarrying 109 139 202 118 232 739 0.9 3.3 Secondary Sector 108 146 162 128 189 316 19.5 22.4 Manufacturing 112 151 166 129 187 298 14.1 14.9 Electricity, Cas 116 176 236 108 202 318 1.0 1.8 Tertiary Sector 111 150 201 127 184 291 29.7 38.2 Transport & Com. 115 163 221 116 176 258 4.6 6.1 Trade, etc. 106 149 172 140 195 356 11.2 14.3 Public Ad.., Defense a/ 121 172 306 112 144 175 4.1 5.0 Total GDP: Factor Cost 105 135 159 139 176 298 100.0 100.0 Market Prices 105 135 160 139 179 303 Memo Items CPI Industrial Workers 134 178 294 CPI Agricultural Workers 147 165 269 Price Index Private 146 179 314 Consumption b/ Price Index Investment 130 198 364 Wholesale Price Index 140 186 315 aI Low price index and consequently high production index are related to the fact that, in the national accounts, for public sector employees, only payments which formally compensate for inflation (dearness allowances, etc.) are counted in the price component. It would be more realistic to count all wage increases (which are about equivalent to the rate of inflation) in the price component of public sector production and consumption. The questionable estimates for this component also influence indices for total GDP and its price. b/ Derived as a residual consistent with other national accounts data. 21. One important factor contributing to this higher growth is that the economy has become less susceptible to weather-induced growth interruptions, for two reasons. Firstly, the weight of agriculture in the economy has fallen. This occurred at first very slowly, from 50% in 1950/51 to 48Z in 1960/61 and 46Z in the early 1970s. After that, however, a precipitous decline occurred, to 38% in the late 1970s and 34% in recent years (for the reasons see further below). Secondly, with increasing prevalence of -16- irrigation, agriculture itself is becoming less dependent on the weather. Recently, about 30% of the total gross cropped area has been irrigated, against 20% in the mid 1960s. With increased inputs, the yield differential between irrigated and non-irrigated cropping has probably been widening. As a result, by now, an estimated 40-45% of agricultural output is produced on irrigated land. While other factors may also have been involved, the fall in agricultural production in 1982/83 of 2.5% was certainly much less than it had been in earlier drought years. 22. Agriculture showed a modest acceleration in growth, from 2.3% to 2.6% per annum, between the decade of the sixties and the decade beginning in 1973/74. As against this, over the same periods, manufacturing decelerated from 5.2% to 4.0% per annum Thus, in comparison with overall GDP growth of 4.2% per annum, since 1973/74 and considering the leading role that manufac- turing commonly plays in developing countries, manufacturing became a lagging rather than a leading sector. This was, however, largely the result of manufacturing's poor performance in the second half of the period. Between 1974/75 and 1978/79 manufacturing had grown by 7.5% per annum compared to 6.1% for the economy as a whole; from 1978/79-1983/84 its growth averaged only 1.6% per annum compared to an overall average of 2.3% for the rest of the economy and a decline averaging 0.7% per annum for agriculture. It appears that industrial growth was held back by a combination of slack demand from the agricultural sector and a less buoyant external environment (exports grew by only 3% per annum over the same period, compared to 8.7% per annum for the period 1973/74-1978/79). 23. Taken together, agriculture and industry continued to grow at a rate of roughly 3% per annum in the decade 1973/74-1983/84. As against this, the service sector accelerated significantly, from 4.8% to 6.1% per annum This was due in part to more rapid growth in a number of important subsectors (including transport, banking and public administration) 1/ but in part also to shifts in weights between the various subsectors, towards the more rapidly growing ones. This same factor is working also between the primary, secon- dary and tertiary sectors of the economy, and with the weight of the slowly growing agricultural sector diminishing rapidly, this bodes well for the future. It seems clear, however, that, without an acceleration of growth in the manufacturing sector, a further step-up in the overall growth rate will be difficult to accomplish. 24. Changes in the structure of the economy and in relative incomes are brought about not only by sectoral differentials in real growth rates, but also by relative price movements. Table 1.2 contains information on both. Differentials in real growth, which have already been discussed above, have been quite significant. The same can be said about relative price movements. The effect on real incomes created in each sector can be gauged by calculat- 1/ See Table 1.2, note al. -17- ing the sector's terms of trade, i.e. by comparing the value added price index with the domestic price indices given at the bottom of the table. 1/ Of particular interest are the price developments in agriculture, with its large number of independent farmers and therefore its close connection between sectoral value added and the incomes of its workers. In this sector, the terms of trade improved significantly in the early 1970s, a period of food scarcity and high agricultural prices. In 1973/74 the value added price index was higher than any of the domestic price indices. By 1978/79, this situation had been however reversed, and by 1983/84 agriculture's value added price index had, in comparison with 173/74, fallen in relation to the general consumer price index by 20%. It is however important to note that the same deterioration did not occur in relation to the consumer price index for agricultural laborers, an- index which can also be considered to be indicative for consumers prices faced by small farmers. Thus relative prices did not deteriorate (or, in comparison to 1973/74, deteriorated only insignificantly) for a very important relatively disadvantaged group. The fact that prices for the consumer basket of this group (and, to a lesser extent those of industrial workers) increase less than the average, can be seen as an impor- tant success for the Covernment's price and social policies. 25. The above also implies, however, that, from a production standpoint, agricultural entrep:eneurs may have been facing a reduction in their term3 of trade -- but given improvements in efficiency through technological innovation, not necessarily in relative incomes. (The analysis is also made more complex by the need to examine the relative cost of agricultural inputs, which lies beyond the scope of this note). The relative reduction in the price of value added in important segments of the agricultural sector sig- nifies that the benefits of technological advances and consequent reduction in costs are being passed on to the consumer. It would be extremely impor- tant if the same mechanism could be made to work in manufacturing industry. For the moment, the fact that the price index for manufacturing shows a lower increase than the consumers of wholesale price indices is probably due to the declining profitability of the sector, rather than to its technological progress. The transport sector shows an even lower price index for value added, probably for much the same reasons. 26. For the rest, Table 1.2 shows some features which were to be expected, such as the large increase in the price of value added for mining, caused by the developments in the energy sector. Also to be noted is the relative price increase for investment goods, which contributed to a rapid increase of the price of value added in the construction sector, especially since 1980. 1/ Comparison with the CDP deflator would fail to take into account the effects of the international terms of trade loss. -18- F. Efficiency of Capital Use 27. India has been quite successful, compared to other developing countries, in increasing its investment rate. In fact, the current rate is roughly twice that of low income economies excluding India and China (WDR 84, p.226), and is comparable to the rate in many upper middle income and industrial economies. It is widely felt, however, that the country is not getting adequate returns from the investment it is making, and that much could be done to increase the efficiency of India's capital assets through policies that encourage competitive efficiency and investments that relieve critical infrastructural bottlenecks, particularly in energy, transportation and communications, so as to reduce the upward pressure on the incremental capital/output ratio (ICOR). Five-year period ICOR's rose steadily over the yaars from 1951/52 through 1974/75 (Table 1.3). There seems, however, to be evidence of a decline in the ICOR during the period 1975/76-1979/80. 28. A more detailed analysis of these trends on a rolling annual basis using subsectoral data indicates that during the period 1974/75-1978/79 capital/output ratios did decline, particularly in the primary and secondary sectors, largely because of the substantial growth of value added while investment continued to grow at a more modest rate (Figure 1.3 and Table 1.4). 1/ 1/ This analysis is based on lagged investment data that recognize normal gestation periods for investm,!nt (varying from one to four years between subsectors). It uses smoothed rolling averages for both investment and output in order to remove the statistical noise common in this kind of analysis so that underlying trends become more apparent. For any given year, incremental capital is taken as the sum of investment for the five years ending n years earlier, where n is the number of years by which investment is lagged. For the same year, output is taken as the dif- ference between adjusted value added in that year and adjusted value added five years earlier. The two end years are adjusted by taking a three year average centered around the end year. This approach subetan- tially reduces the random variations associated with actual annual data, but allows year by year calculation so that turning points in trends can be more accurately determined. -I Figure 1.3 INDIA incremental Capital/Output Ratios 1973/74 - 1982/83 cons 16.5- 13.5 10.5 7.5 -dol (v82)omløø*øøøø 4.5 -P» 4,5 Pnay Sector (VOl) ' n .5 iii 74 75 76 77 78 79 80 81 82 83 Fiscal Yers Wodd Bw*-27358 -20- Table 1.3: GROSS/NET INCREMENTAL CAPITAL-OUTPUT RATIOS (1970/71 Prices) Series A (including Series B (excluding investment in inventories) investment in inventories) Period Gross Net Gross Net Five Year Spans 1951/52 to 1955/56 3.13 2.25 3.02 2.15 1956/57 to 1960/61 4.13 3.98 3.69 2.75 1960(61 to 1964/65 3.23 2.45 3.03 2.25 1965/66 to 1969/70 6.59 5.18 6.24 4.61 1970/71 to 1974/75 8.88 6.59 7.72 5.36 1975/76 to 1979/80 5.08 3.93 4.57 3.37 Ten Year Spans 195051 to 1959/60 3.80 3.23 3.50 2.58 1960/61 to 1969/70 4.54 3.48 4.28 3.21 1970/71 to 1979/80 6.27 4.77 5.55 4.00 1970/71 to 1981/82 5.66 4.35 4.75 3.39 Note: The estimates for the years up to 1979/80 are based on data furnished in Statistical Annexes 3, 4, 6, and 10 in the Report of the GO Working Group on Savings. The estimates for the period 1970/71 to 1981/82, given in the last row, are however based also an data available additionally for recent years from CSO's "National Accounts Statistics, 1970/71, to 1981/82" (January 1984). Source: K.N. Raj. "Some Observations on Economic Growth in India over the period 1952/53 to 1982/83", EPW, October 13, 1984, p. 1803. -21- Table I.4 IGIA: Inrreaental CapitallOutput Ratios, 1973174-1982/83 ITEM 1973174 1974/75 1975/76 1976it 1977170 1970179 1979/80 1980/01 1981/82 1982/83 Primary Sector 61 3.9 3.6 5.4 3.3 2.0 2.7 4.6 5.3 6.7 6.2 Agriculture 62 3.7 3.4 5. 3.1 2.5 2.4 4.0 4.4 5.6 5.5 Forestry&Lcggir 63 2.9 3.3 6.8 -7.6 -4.1 -2.6 -2.0 -1.5 -1.7 -2.3 Fishing 64 4.9 4.3 4.3 4.7 5.5 7.2 11.0 16.2 11.3 7.8 Mining & Quarry 65 9.7 7.5 6.2 5.3 6.1 7.2 11.1 14.5 13.B 10.0 Secondary Sector 66 10.5 11.5 10.0 7.9 6.4 6.0 6.1 7.5 9.6 12.6 Hanufacturing 67 B.5 9.0 8.7 8.0 6.B 6.4 6.1 7.3 9.0 12.2 Registered 68 9.4 10.7 10.3 8.8 7.2 7.0 6.5 7.6 9.6 13.8 Unregistered 69 6.3 6.2 6.3 6.6 5.9 5.2 5.2 6.6 7.5 8.9 Construction 70 -30.6 -12.6 12.2 2.5 1.5 1.4 1.7 2.7 4.6 6.0 Electricity,Gas 71 18.9 19.7 1.2 16.4 14.5 13.7 14.3 16.1 17.7 19.1 Tertiary Sector 72 6.2 5.9 5.8 5.2 4.6 4.2 4.1 4.0 3.8 3.7 Transport, Star 73 7.8 7.4 6.7 6.4 5.8 5.6 5.2 5.1 4.9 5.0 Railways 74 27.5 22.2 13.6 9. 9.3 7.5 7.4 7.7 8.6 9.4 Other transpor 75 5.6 5.0 4.8 5.2 5.2 5.1 4.7 4.6 4.1 3.9 Coamunication 76 4.8 5.0 5.0 4.9 5.1 5.1 4.8 4.7 4.5 4.3 TradelRestauran 77 2.9 2.6 3.1 2.8 2.6 2.7 3.0 3.5 3.7 3.B Bankingtinsuran 78 .7 . .B .6 .5 .4 .4 .5 .6 .7 Real Estate 79 26.9 26.4 25.8 22.9 20.3 19.9 20.9 17.5 14.4 12.9 Public Adamin 0 4.0 4.2 5.1 4.9 4.4 3.6 2.6 2.0 1.8 1.7 Other Services 81 4.1 3.5 2.9 3.0 3.2 3.2 2.9 2.6 2.4 2.0 TOTAL 82 6.5 6.2 6.7 5.2 4.5 4.3 4.8 5.2 5.6 5.8 Source: Based on'data in constant 1970/71 prices from Section 2 of the Statistical Appendix. Note: The ICORs shown in this table represent five-year averages ending in the year specified. Value added has been calculated as the increment between three-year averages centered on the first and last year of each five-year period. Investment is the sum of gross domestic capital formation over five years, lagged appropriately for each sector with respect to the value-added data. -22- Table 1.5: SELECTED PUBLIC SECTOR AND ECONOMY-WIDE INCREMENTAL CAPITAL/OUTPUT RATIOS a/ 1961/62-1973/74 1974/75-1981/82 Agriculture: Public 22.2 13.1 Total 3.7 4.5 Energy and Mining: Public 8.1 12.9 Total 8.1 18.0 Manufacturing: Public 11.8 30.5 Total 8.3 8.8 Electricity Gas & Water Supply: Public 16.7 24.5 Total 16.2 21.8 Railways 18.2 8.1 Other Transport: Public 8.9 7.1 Total 7.6 4.6 Communications 5.2 5.2 Public Administration 5.3 2.5 Other Services: Public 1.2 0.9 Total 6.1 2.8 Total Public Sector 7.5 6.4 Total Economy 5.9 5.7 a/ The ICORs are estimated by using the Harrod Domar growth equation, ICOR=Investment rate, with the GDP growth rate estimated by linear CDP growth rate regression. Source: Central Statistical Organization, National Account Statistics, January/February 1980 to 1984 (for GDP and gross domestic capital formation data at 1970/71 prices); and Bank staff calculations. 29. The foregoing analysis has focused on broad trends for overall and sectoral ICORs. It is interesting however, to e)amine the ICORs separately for the public and private sector (Table 1.5), for these show notably dif- -23- ferent trends, perhaps largely because of the different nature of investment undertaken by the public and private sectors; there may, hGwever, also be some efficiency differences. 30. The increase in the ICOR for the Doblict min-ng sector, which was largely accounted for by coal and petrnleum, reflected the fact that until 1980/81 the substantial increase in public investment in coal and petroleum-- an increase by about 160% in these two suboectorn during the Fifth Plan over the Fourth Plan--was not matched by a corresponding expansion in production, particularly of ccal. Coal output increased from 88.4 million tons in 1974/75 to about 100 million tons in 1976/77 and stagnated at this level until 1979/80. Oil production increased from 7.7 million tons in 1974/75 to about 11 million tons in 1977/78 and remained at this level until 1980/81. Public investment in coal and petroleum Rgain increased substantially since 1979/80, particularly with the launching of Lhe Sixth Plan in 1980/81, and the growth of both coal and oil production has also accelerated conoiderably. Coal prcduction increased quickly in 1980/81 and 1981/82 due partly _o improvements in operational efficiency but more to the easing of the tran- sport bottlenecks. The expansion of petroleum output started accelerating in 1981/82 as the exploration efforts began to bear greater results; increased oil production from the Bombay High fields was particularly important. 31. In electricity, gas and water supply, the ICOR rose significantly since 1974/75, particularly during the recent period of 1979/80-81/82. These increases largely reflected the conditions in the power subsector which dominated this sector. Public investment in power during 1974/75-78/79 was 56% higher than during 1969/70-73/74, and again about 40% higher during 1979/80-81/82 than during the Fifth Plan on an annual basis. However, the rate of growth of power generation actually decreased particularly during 1979/80-81/82 when capacity utilization dropped to about 45%, compared with around 50% during 1974/75-78/79, because of drought, shortages of coal and transport services, and other constraints as well as Low operational efficiency. 32. In public manufacturing industries, the ICOR for the period since 1974/75 has increased dramatically. Public investment in manufacturing during this period increased at annual rates as high as did investments in power. However, the growth of public manufacturing CDP dropped substantially as capacity utilization in iazy public manufacturing industries deteriorated, particularly during 1979/80-81/82 because of shortages of power, imports, feedstocks and transport services, obsolete and improperly balanced plant and equipment and inadequate demand for some industries. The industries most seriously affected included steel, fertilizers, aluminum and heavy engineering. Also, large-scale plants like the naphtha-based petrochemical complex in Baroda were under construction, which reised investment without a simultaneous increase in output. 33. The railways subsector experienced the most dramatic drop in its IGOR for the period since 1974/75. Investment in the subsectot was cut back while -24- the railways' assets were being stretched and utilized at high rates to reach record levels in 1977/78 and to result in the dramatic increase in the rail- way value added growth rate from 3.4% per annum during 1961/62-73/74 to 6.3% per annum during 1974/75-78/79. Railway GDP growth slowed down to 4.0% during 1979/80-81/82, with some deterioration in capacity utilization as the impact of the backlog of replacement and modernization became more serious. At the same time, in a reversal of the trends of the Fourth and Fifth Plans, investment in the railways increased substantially during 1979/80-81/82. 34. The substantial drop in public agriculture's ICOR after 1974/75 largely reflected the relative cutbacks in investment while high GDP growth was maintained by the expansion of the benefits of public investment in irrigation through improvements in agricultural extension and other support services. These benefits accrued to the agriculture sector overall. During 1974/75-78179, growth of agricultural GDP accelerated from 2.0% to 3.9% per annum compared to 1961/62-73/74. However, this growth rate dropped to 1.5% per annum during 1979/80-82/83, in part because of the inadequate use of the irrigation potential that had been created, and iL part because of the droughts of 1979/80 and 1982/83. As a result, the ICOR for overall agricul- ture for the period after 1974/75 was higher than that for the period 1961/62-73174. 35. Increasingly longer gestation lags of public investment in some sectors explained in part the increase in investment cost that contributed to the rise in the ICORs discussed above. The pr-iblem of the long gestation lags has been serious because the sectors subject to substantial delays in project implementation are highly capital intensive. For example, during the first four years of the Sixth Plan, the gestation period for hydro-electric power projects that were commissioned increased from 79 to 121 months. Although there was no clear trend in the lengthening of the gestation period for thermal power projects commissioned during 1980/81-83/84, the average of 79 months was much too high compared with the norm cf 48 months. In irrigation, the excessive proliferation of projects contributed substantially to the lengthening of the gestation period and the blocking of large invest- ment resources in unproductive assets. Since 1950, some 900 major and medium irrigation projects have been started, and 622 projects remained unfinished at the start of the Sixth Plan. 1/ 36. From an economic point of view, higher ICORs mean less growth from a given level of investment or, conversely, less consumption enjoyed from a given level of growth (assuming that beyond a certain level of foreign savings dependence, additional investment must come out of additional domes- tic savings). For example, with a 21% investment rate, India could notion- ally sustain an average growth rate of about 4.7% at the gross ICOR of 4.5 1/ World Bank, Situation and Prospects of the Indian Economy - A Medium-Term Perspective, Vol. II, 1984, p. 164. -25- that prevailed during the 1960s. 1/ The fact that growth was actually 4.2% per annum implies that the actual ICOR was 5.0. Thus, a reduction to the earlier ICOR could raise the growth rate by 0.5% per annum without increasing the ate of savings or dependence on foreign borrowing. 37. There is sufficient evidence in India today of inefficiencies in the use and maintenance of capital stock to prove beyond doubt that India's economic growth and social welfare objectives could be furthered substar- tially if effective measures were put into effect to increase output from existing investments, and/or lower incremental investment costs and ratios. For example, if one could assume that, in any given year, new investment is equal to 5% of installed capital, an increase of only 5% in the rate of capacity utilization would generate additional output equal to the output generated by new investment in that year. 38. While the potential returns to increased efficiency are obviously high, there are definite limits to the extent to which ICORs can be reduced because of the common tendency for them to rise as an economy becomes more technologically developed and sophisticated. India's experience of rising ICORs has been a ccmmon phenomenon throughout both the developing and developed world (Table 1.6'. 39. This underlines the need to combine stress on efficiency with con- tinued efforts to support a level of savings sufficient to meet the nation's need for a pattern and rate of economic growth that will increase both the welfare of all citizens and the ability of the economy to adjust to future internal and external shocks. 1/ These calculations are based on the simple Harrod-Domar growth equation where change in capital (investment) divided by the ICOR gives change in output. This is only good as a simple example because, among other things, it ignores technological change. -26- Table 1.6: INCREMENTAL CAPITAL/OUTPUT RATIOS IN WORLD MARKET ECONOMIES AT 1975 PRICES 5-Year Averages 10-Year Averages 1960-65 1965-70 1970-75 1075-80 1960-70 1970-80 World Market Economies 4.1 4.7 7.1 6.4 4.4 6.7 Developed Economies 4.3 5.1 8.3 6.7 4.7 7.4 Developing Economies 3.2 2.9 3.8 5.4 3.0 4.6 India a/ 3.0 6.2 7.7 4.6 4.3 5.6 a Gross investment excluding investment in inventories. Source: K.N. Raj., op. cit. -27- Attachment A SHOCKS/ADJUSTMENT ANALYSIS - DETAILED RESULTS A.1 This attachment provides a more detailed analysis of the size and nature of each of the shocks and adjustments summarized in the main note. This analysis is presented as above in terms of the first and second adjust- ment periods. After this, Attachment B provides some background methodologi- cal notes, while Attachment C provides tables shoving the detailed inputs and results of the shocks/decomposition model on an annual basis. The First External Shock A.2 In 1973/174, world oil prices rose four-fold. This radical price change for such a key product quickly led to cascading changes in the prices of other goods in world trade, particularly those derived directly or indirectly from petroleum products (e.g. fertilizers and foodgrains). The problems of adjusting to the new world prices caused a major slowdown in the growth of the industrial economies. 11 As a result, the world market for the exports of developing countries had contracted sharply by 1975, and during the remainder of the decade, was unable to regain the average growth of 8.5% per annum that it had achieved between 1963 and 1972 (ibid., p. 176). However, once world trade began to recover from its initial shock, prices of many LDC exports rose substantially, partly offsetting the effects of higher import prices for a number of countries including India. A.3 In addition to the price and volume shocks of this period, which greatly increased the financing requirements of non-oil developing countries, there was a surge in interest rates that markedly increased the nominal cost of such borrowing. The Euro Dollar London rate, for example, rose from an average of 6-7% per annum in the decade prior to the first oil shock to over 11% in 1974. However, since international inflation percentages were even higher, real international interest rates were negative throughout most of the period of the first oil shock. A.4 For India during the five-year period 1974/75-1978/79, the key ele- ments of the first shock and their respective average contributions to the total net shock as a percentage of CDP, were terms of trade loss (-1.8%), export demand recession (-0.3%), and expanded demand for factor Services -- mainly Indian workers in Gulf States (+0.6%). The terms of trade shock was the net effect of higher import prices (-2.6%) and higher export prices 1/ Growth slowed from the 4.7% per annum average of 1963-72 to 0.5% in 1974 and CDP fell by 0.6% in 1975 (IMF, World Economic Outlook, 1983, p. 170). -28- (+0.8%). 1/ Cumulatively these resulted in a shock for the period averaging -1.4% of DP. A.5 Import Price Shock. Between September 1973 and the following March, OPEC raised its oil prices from US$2.70 to US$11.20 per barrel. 2/ As a result, between 1972/73 and 1974/75, India's oil import bill shot up from US$265 million to US$1,451 million, and from 11% to 26% of the total import bill, despite an 8% contraction in the volume of crude oil and POL product imports during this period. Rising prices of other imported goods also contributed to the overall increase in India's import bill. Oil, however, was the major factor, accounting for 9oz of the total net shock in 1974/75. If oil prices had risen at the same rate as other import prices between 1972!73 and 1974/75, the current account deficit in 1974/75 would have been almost zero rather than 1.4% of CDP. A.6 As a result of these import price developments, the overall share of imports in GDP rose sharply -- from 4.3% to 6.9% between 1972/73 and 1974/75, and to 8.1Z by the following year. The nt import price shock of -2.6% of GDP was, however, considerably less than the -4.9% shock experienced by other primary producing countries. A.7 Export Price Counter-Shock. Rising export prices offset a substan- tial part of the import price shocks in most developing countries after 1973/74; in primary producing countries, for example, the export price counter-shock was equivalent to 3.2% of CDP. In India, however, the export price counter-shock was only 0.9% of GDP, a reflection in large measure of the relatively small size of foreign trade in the Indian economy. The over- all terms of trade shock (-1.8%) was almost the same as in other primary producing countries (-1.7%). A.8 Export Demand Recession. A major share of India's exports went to other developing and Eastern Bloc countries during this period, rather than to the developed Western countries that were, at least initially, in the grips of recession. In large part as a result of this, India fared better than most primary producing countries in terms of demand for its export products. During the period 1973/74-78/79, import demand in India's key trading partner countries grew by about 8.3% per annum, compared to overall world economic growth of 2.7% per annum The shortfall in export demand attributable to economic recession in India's key trading partner countries 1/ A minus (plus) sign indicates an effect which worsens (improves) the current account position. 2/ Average OPEC price, Price Prospects for Major Primary Commodities, IBRD, 1984, Vol. 5. -29- compared to the 60s accounted for less than 0.5% of GDP during this period, compared to 2.0% for primary producing countries in general. 1/ A.9 Factor Service Income. The explosion of construction and related activities in the petroleum-exporting Arab countries following the 1973/74 oil price hikes led to a demand for labor that was met in part by a major outflow of Indian workers. Largely because of the return inflow of private transfers and workers remittances, India's net factor servie income (includ- ing transfers and excluding nt interest payments) grew from US$149 million in 1973/74 to US$1,534 million in 1978/79, accounting for the counter-shock averaging about 0.6% of GDP, that was noted above. 2/ By 1978/79 private transfers were contributing about 14% of total current account earnings. A.10 Other Shocks. In addition to the major shock elements mentioned above, India was also affected by price changes on factor and non-factor services, demand for non-factor services, and changes in interest rates. None of these elements, however, appears to have been as significant as the others listed above, at least during the first post-shock period. Modes of Adjustment Following First Shock A.11 During the period following the first oil shock, primary product producing countries on average adjusted in equal measure by contracting imports and expanding exports. However, such efforts fell far short of the total adjustment effort required and about 80% of the shock had to be covered by additional external financing. 3/ India, in contrast, was able to adjust quite rapidly to the first oil shock. In fact, despite notable year-to-year fluctuations in growth, the average growth rate for the five years 1973/74-1978/79 was higher than that 1/ WDR 1981, p. 66. 2/ Some shocks/adjustment methodologies, including that used in the 1981 WDR, pool factor service incomes and private transfer payments with external financing, which makes their results not entirely comparable with those presented here. This separate treatment was given here in view of the fact that (a) factor service incomes played an important and separably identifiable role in India's economic development and policy making after 1973/74 =nd (b) these flows were in large part the result of exogenous factors beyond the control of the Government and thus should be grouped with shocks rather than adjustments, which are actions induced by Government policy. 3/ WDR 181, p. 66. This also reflects the smaller share of trade in GDP for India than in other countries on average. -30- for the 1960s. The relative ease with which India adjusted to the first oil shock may e attributed to a variety of factors. A.12 First, for reasons noted above, the shock to India was considerably less than that experienced by other primary producing countries. Second, while many countries were forced to adjust to the first oil shock through a substantial contraction of imports and of domestic economic growth, India was able to handle two-thirds of its basic adjustment (which averaged 2.1% of GDP) through increased export efforta in the areas of goods and non-factor services. On the import side, rather than allowing import growth parallel with CDP (as assumed in the "counterfactual"), India initially continued its restrictive policies, keeping imports at an essentially constant level as it had done in the previous decade, and this accounted for about 40% of the adjustment process. Finally, the additional imports arising from a quicken- ing of GDP growth accounted for a small negative average adjustment of 0.2% of GDP. A.13 Exports. The expansion of India's exports of goods and non-factor services above expectations based on past trends during the period 1973/74-1978/79 reduced the current account deficit on average by about 1.4% of CDP. Export growth in real terms, while fluctuating substantially from year to year, attained an average of about 7% per year between 1973/74 and 1978/79 and exports rose in current prices from 4.8% of GDP in 1973/74 to 7.6% by 1976/77, declining slightly by the time of the second oil shock to 7.2% of GDP. A.14 The key factors behind India's export success during this period were (a) the combination of an exchange rate policy and domestic inflation control through demand management that increased the exportable surpluses of domestic production and raised the relative profitability of export sales; (b) various specific policy measures such as preferential access for exporters to imported inputs, tax and related incentives to exports; (c) active develop- ment of domestic industries (particularly in light engineering goods) to the point they began to be internationally competitive, and (d) an import policy that made it easier than in the past to obtain imported inputs for export production. A.15 Imports. India's case stands apart. While imports were kept down during the first part of the period, they were allowed to expand substan- tially after the initial balance of payments deficits were eliminated. This was part of a longer-range policy to (a) support export efforts, and (b) evercome domestic production bottlenecks, thereby increasing the economy's efficiency. Thus, in 1978/79 and 1979/80, imports grew very rapidly, and in the latter year they were, in real terms, 23% higher than in 1973/74. During the same period, GDP was growing by about 5% per annum, implying an overall import elasticity in real terms of about 1.4. In current prices, imports rose from about 4% of GDP in 1972/73 to about 8% by 1975/76 and remained near that level until the second oil shock at the end of the decade. -31- A.16 External Financing. Primary producing countries as a whole during the period between the two oil shocks paid for about 70% of the shocks through increased real external financing. In India, on the other hand, counterfactual adjustments exceeded shocks and the country was able to increase its external reserves (increased factor servie income, which is included as a financing item in other analyses, was equal to about 28% of adjustment). With the "counterfactual" current account negative by about 1% of GDP, it is assumed that, in the absence of the oil shocks, India would nave held exports at levels that would have absorbed available concessional financing. A.17 As compared to the total financing need of close to US$2 billion, actual net capital inflows amounted to US$6.3 billion. In response to India's predicament as an oil importer, grants rose raidly following the first oil shock, from about US$100 million in 1973/74, to roughly US$500 million from 1975/76 onwards, for a total of about US$2.1 billion over the period. Initially, to finance its heavy current account deficits, India rapidly increased its borrowing, from about US$600 million in 1973/74 to over US$1.3 billion in 1975/76. Thereafter, with the current account moving into surplus, the Government slowed the pace of net borrowing, and by 1978/79 it had fallen back to US$600 million -- lower in real terms than in 1972/73. This reduced borrowing requirement enabled a shift towards higher concessionality: the average interest rate on new commitments fell during the period from 2.2% to 1.9%, and new commitments of public debt from private sources fall from 5% of the total in 1973 to 1% in 1978. Total loan financ- ing during the period mounted to about US$4.7 billion. A.18 Except in 1976/77 when India experienced a net outflow of US$625 million to the IMF and "capital, nie," these sources of financing did not, on a nt basis, play a major role in the financing of the adjustment process. In abaclute terms, however, the IMF played a substantial role in the immediate aftermath of the first oil price shock, making available over US$800 million net during the first three years. Given these various move- ments in the capital account, and the unexpected speed with which the current account deficits were eliminated, a substantial and largely unintended increase in reserves, of about US$5.8 billion developed during the period, bringing these reserves up to 9 months of imports in the peak year 1978/79. The Second External Shock A.19 During late 1979 and early 1980, OPEC raised its average price of crude oil from US$13 to US$30 per barrel, a price 23 times what it had been 10 years earlier. By the time of the second oil shock, the world economy was still recovering from the first shock. The process of making longer term structural adjustments in physical production facilities to higher energy prices was still going on. Also, many countries had been forced to sharply expand their outstanding external debt. Thus, when the second oil shock -32- came, the world's ability to adjust to further oil price increases was less than after the first oil shock. A.20 Even the industrial economies were seriously affected by this second oil shock. Their real average growth rate fell from 4% per annum in 1978/79 to 1.5% per annum in 1980/81, and to 0.1% in 1982. As a result of this recession in the more developed economies, the demand for imports from the developing countries fell sharply, generating further price and volume shocks on the export side of their balance of payments. Because of the scarcity of funds in world financial markets compared to the early 70s and the higher risks associated with lending to countries already straining to meet their debt service obligations, interest rates went up sharply. Many commercial banks moved to loans on floating interest rate at a margin cver the London Inter-Bank Offer Rate (LIBOR), which on 6 month dollar accounts rose from 9.1% in 1978 to 16.6% in 1981. With inflation rates dropping sharply, real interest rates became highly positive. At the same time, with the recession and consequent budgetary cutbacks in the developed countries, official for- eign assistance flows to low income oil importing countries expanded by only 24% per annum in nominal terms in 1979 and 1980 compared to 37% per annum in the two years after the first oil shock; 1/ in real terms the growth of assistance was 13% per annum A.21 All of these factors adversely affected India, though to varying degrees. Falling terms of trade were by far the most important, however, accounting for over 120% of the 2.6% deterioration in India's current account balance during the period 1979/80-1983/84. Import price shocks (4.3% of GDP) were further aggrevated by falling export demand (-0.8% of GDP), but these shocks were partially offset by countershocks in the form of higher export prices (1.0% of GDP), and other factor service income -- largely workers' remittances (1.4% of GDP). Other elements had a negligible impact. A.22 Before going on to discuss each of these shocks separately, it should be noted that these external shocks were compounded in India's case by a series of adverse internal developments including (a) a crisis in Assam which severely curtailed domestic oil production, forcing higher oil imports in 1979/80 and 1980/81; (b) a severe drought that resulted in a 13% decline in agricultural GDP in 1979/80 and (partly because of the drought) serious infrastructural bottlenecks. A.23 Import Price Shock. Of the total import price shock after 1978/79, 75% was due to oil price increases. By the time of the second oil shock, India had not yet realized the full fruits of the energy exploration work that had been underway since the first oil price shock. It was still import- ing nearly 60% of is domestic crude consumption, a figure not much lower than 1/ World Debt Tables, World Bank, 1981. -33- the 65% it was importing at the time of the fist oil shock. 1/ At the time of the 1979 oil price changes, oil constituted about 25Z of India's total import bill, so the impact of a 156% increase in oil prices between 1979 and 1981 was very substantial, contributing about 70% of the total increase in the cost of India's imports between 1978/79 and 1980/81. A.24 As measured in dollars, 2/ price increases for non-oil imports during this period were, in fact, moderate to non-existent on average, reflecting the stagnating world economy. The dollar price index for manufactured goods exported from developed to developing countries fell significantly during this period, benefiting countries like India: Table IA.l: INDIA: PRICE INDICES IN US DOLLARS (1978 = 100) 1978 1979 1980 1981 1982 1983 1984 World Manufacturing Unit Value: Index 100 111 120 116 113 110 114 Annual Change (Z) 17.6 11.2 8.3 -4.2 -1.8 -3.0 3.5 India /a Imports: Index 100.0 140.3 135.3 130.2 126.4 119.6 Annual Change (Z) 40.3 -3.6 -3.7 -2.9 -5.4 Oil: Index 100.0 176.3 256.3 261.3 248.1 222.0 Annual Change (Z) 76.3 45.4 1.9 -5.1 -10.5 Memo Item: SDR (Index of Value in US$) 100 103 104 94 88 86 81 /a Fiscal years. 1/ M.S. Ahluwalia, 1984, Table 13. 2/ The indices in the table reflect not only international prices, but also the strength of the US dollar. Since the whole analysis is done in terms of dollars, that denomination has been retained. The value of the dollar in SDRs is however also indicated in the table. -34- The moderating impact of other import prices on the average cost of imports, combined with the falling share of oil in total imports from 1980/81 on, helped keep the overall rate of inflation for Indian import prices well below that for oil importst as can be seen above. Moreover, towards the end of the period, petroleum prices themselves declined, at least in dollar terms. A.25 Exeort Price Shocks. Unlike the aftermath of the first oil shock, when India's average export prices rose by 50% in five years, India's export prices after the second oil shock did little to offset the higher import prices. In fact, after a brief jump in 1980/81, its export prices fell in dollar terms every year thereafter end, by 983/84, were lower than they had been in 1979/80, a reflection of the recession that gripped the world during that period, and of the appreciation of the dollar. But as India's average import prices started to drop earlier than its export prices, is terms of trade recovered somewhat in the second year. 1978/79 1979/80 1980/81 1981/82 1982/83 1983/84 Terms of Trade 1973/74 = 100 85 67 64 61 61 62 A.26 Export Volume Effect. Of the net shock between 1978/79 and 1983/84, about 30% was due to falling demand for exports because of economic recession among India's principal trading partners. The additional shock from this source was minimal between 1978/79 and 1980/81 (0.2% of CDP), but became particularly serious in 1982/83 when world growth virtually came to a halt, and the developed market economies actually contracted slightly. 1/ A.27 Factor Service Income. Workers remittances and other transfers and non-interest factor incomes played an even more important role in the period immediately after the second oil shock than they did after the first. Between 1978/79 and 1980/81 the countershock of these flows increased from 1.0% of GDP to 2.0% reflecting the additional surge of economic activity in the Gulf States with the almost three-fold increase in oil prices between 1978 and 1981. This impact reversed sharply starting in 1981/82 however, as world recession weakened the demand for oil, pushing down oil values and prices, and thus revenues of the oil exporting countries where large numbers of Indians were working. 1/ World Economic Outlook, IMF, 1984, p. 1. -35- Adjustments to the Second Oil Price Shock A.28 The nature of the adjustment process during the period 1979/80- 1983/84 was quite different from the pattern after the first oil price increases, largely in that (a) the export effort for goods and non-factor services stagnated rather than rising sharply, and (b) most importantly, import substitution, which had made a significant positive contribution to the adjustment process during the first post-shock period, had the opposite effect in the second, especially in the period through 1980/81. A.29 Largely because of the substantial negative import substitution after the second shock, India relied more heavily on net foreign savings; this financed nearly 40Z of the net shock during the second adjustment period, compared to the excess of adjustments over shocks in the first. Extarnal Adjustments A.30 Export Expansion. India's exports grew by 11% in 1979/80, a major factor accounting for the average contribution of export expansion of 2.1% of CDP during the period. However, exports grew by only 1.7% per annum thereafter. Thus, after the first year of the second shock period, India's exports made relatively little additional contribution to adjustment; industry and trade policies failed to give adequate incentives to export production, and shortages of inputs (including electric power) were also a serious constraint. Import Substitution A.31 The second oil shock came at the time ot drafting the Sixth Plan, which called for a substantial public investment effort to overcome the various bottlenecks that were hampering India's economic growth and development. Civen the country's very substantial unused borrowing capacity, the Government opted for an adjustment pattern that involved increased exter- nal financing rather than curtailing imports and thus economic growth. As a result cf this policy decision, which as supported by a liberalization of the import licensing system, import volumes expanded by an average of 3.4% per annum during the period from 1978/79 to 1983/84. Since the rate of import growth during this period exceeded the 3.3% growth of GDP, the shocks analysis methodology shows negative import substitution, in effect a domestic countershock. 1/ 1/ It should be stressed that "positive" and "negative" are used here strictly in a positive rather than normative sense, referring to the arithmetic sign of the adjustment rather than to any judgement as to whether this is bad or good. Import substitution as defined here is basically just a measure of whether the elasticity of imports with respect to CDP (both measured in constant prices) is rising or falling. -36- A.32 The majority of the growth of the import bill following the second cil price shock was in imports of crude petroleum, which increased from 25% to 36% of the nominal import biLI between 1978/79 and 1979/80, and further to 411 in 1980/81, during the Assam crisis. Subsequently, the volume of oil imports began to decline as domestic production expanded from 10.5 million mt. iv 1980/81 to 26.2 million mt. in 1983/84. Over the same period oil imports fell by 16% per annum in real terms and to 24% of the total import bill. A.33 Morkers Remittances, Current Transfers, etc. In the discussion of the aftermath of the first oil shocik, the unexpectedly rapid growth of workers' remittgnces and other private transfers was noted. These flows accelerated abruptly with the second oil shock, becoming a major factor in the balance of payrent. Had these additional earnings (with respect to 1978/79 levels) not been available in 1980/81, for example, the current account deficit would have been about 3.2% of CDP instead of only 1.8%. Looked at from another perspective, in the absence of these transfers, India's dependence in foreign financing would have had to be nearly 70% higher. Since 1980/81 however, these flows have stopped growing and have begun to decline notably. As a result, this cushioning counter-effect on other excernal shocks was quickly being eroded, which accounts in large part for the continuing rise of the total shock level after 1980/81. A.34 External Financing. In contrast to the first oil shock period, current account deficits persisted throughout the seond period. Thus the amount of financing needed to cover the deficite was, at US$14.4 billion, very much iarger than during the first period. On the other hand, the period started with unnecessarily high foreign exchange reserves, and these could partly be used -- and were used to an amount of US$1.1 billion -- to cover the deficits. This left a financing need of US$13.3 billion. Of this, slightly more than one quarter was financed by grants, which averaged about US$0.7 billion per annum throughout the period. A net amount of US$5.0 billion was drawn from the IMF. On the other hand there was an out- flow of US$1.8 billion under miscellaneous headings. The remaining US$6.7 billion or half of the total financing need was covered by loans. -.37- Attachment B NOTES ON METHODOLOGY B.1 The shocks/adjustment analysis that was used in this note was based on work pioneered by Bela Balassa and others. Among the works consulted were the following: Ab6luwalia, Montek S. Balance of Payments Adjustment in India, 1970/71 to 1983/84. Prepared for UNCTAD Balance of Payments Adjustments Project, 1984. Bacha, Edmar L. Foreign Debt, Balance of Payments and Crowth Prospects of Developing Countries. Colombia University, December 16, 1983. Balassa, Bela. Adjustment to External Shocks in Deve.oping Economies. World Bank Staff Working Paper, 1981. and F.D. McCarthy. Adjustment Policies in Developing Countries, 1979-83: An Update. World Bank Staff Working Paper, 1984. Mitra, Pradeep K. An Analysis of Adjustment in Developing Countries. World Bank Staff Working Paper, 1981. . Adjustment to External Shocks in SeLcted Semi-Industrial Countris, 1974-1981. World Bank, ERS Discussion Paper, November 1984. B.2 Shocks/adjustment analysis was featured in the 1981 World Development Report by the World Bank and has become fairly widely known and understood since then. The basic principles of shocks/adjustment analysis were laid out in the main part of this report and do not need to be repeated here. This discussion will therefore focus on the types of shocks and adjustments that were included in the India model, the key assumptions made, and the sources of the data. 1/ B.3 Shocks. For the most part, the analysis of shocks and adjustments done for this report followed very conventionail lines. Within the shocks part (ref. Table I.B.1), the analysis was broken duen into price ad demand effects. It is assumed with respect tc export and import prices that; in the absence of the world oil price shocks, prices would have continued to gro;w at 3% per year, a level generally consistent with world inflation in the decade 1/ A listing of the model which shows the actual calculations is available on request. -38- prior to the first oil shock (from 1962 to 1972, for example, the MUV increased by an average of 3.3% per annum). The actual import and export prices were basically taken from published Government sources, but were extended by Bank staff to cover the past few years, using primarily other published Government data. B.4 On the demand side, it was assumed that the demand for exports in the absence of the oil shocks would have continued to grow at the 8.5% real rate indicated for the period 1963-72 in the IMF's World Economic Outlook (Occa- sional Paper 21, 1983). To separate the difference between trend and actual exports into the effect of lower partner demand and additional export effort, it was assumed that the "hypothetical" demand for India's exports was linked to the growth of world trade indicated by the same IKF source for the period from 1973/74 through 1963/84. For both the trend and hypothetical export growth rates an elasticity of 0.45 for growth of Indian exports with respect to world demand was assumed. This value is consistent with the experience of India with respect to the IMF world trade data for the 60s. B.5 Factor service incomes plus net current transfers. which are dominated by remittances from Indians working abroad, have been a very impor- tant element in the adjustment process over the past decade. The counterfac- tual trend and hypothetical cases are developed on the same basis as exports. B.6 For interest payments, the counterfactual assumes that India's inter- est rate costs would have grown by 3% per annum in nominal terms. B.7 Adjustments. The export effort has already been touched upon above in the discussion of the trend and hypothetical export demand assumptions. With respect to import substitution and the GDP slowdown effect an imports, it was assumed that, in the absence of the oil shocks, imports would have grown with an elasticity of 1.0 with respect to GDP growth, and that GDP would have grown by the well-known "Hindu rate of growth" -- 3.5% per annum The difference between the trend imports and the hypothetical imports that would have taken place at the same elasticity but with the actual rate of growth gives the GDP slot-down effect on import demand. The difference in turn between the hypothetical and actuax levels of imports provides the import substitution effect. B.8 Because of the way in which the shocks and adjustments were calculated, the net adjustments (the algebraic sum of shocks and adjustments) plus the counterfactual current account deficit (the deficit based on the assumption of trend growth in exports, imports, etc. on current account), is equal to the actual current account. B.g The difference between shocks and adjustments on current account may be regarded as the incremental financing required. to compensate for any shocks not fully compensated by "real" current account adjustments. -39- Attachment C DATA DOCUMENTATION The following tables provide details of the shocks/adjustment analysis that are not presented in the text. The following information is available here: Table I.C.1 - Annual percentage of GDP values for each of the shocks and adjustments. Table I.C.2 - Annual values in millions of US$ for each of the shocks and adjustments. Table I.C.3 - Background details on the analysis of import shocks, both total and for oil. Table I.C.4 - Full listing of all variables used in the model and their values upon completion of the run. -40- Table I.C.1 Table IDI'SA-2 INDIA: Structural Adjustmrt Analysis - kcopositio, 1973/74-1953/B4 (percentages) 1973/74 1974/75 1975/76 1976/77 1977/78 1978/79 1979/80 1980/81 1W1/02 1982/83 1983/84 External Shocks Price - nWt effect 55 0.0 -1.6 -2.6 -1.9 -1.5 -1.3 -3.1 -3.4 -3.5 -3.3 -2.9 Import Prices 45 0.0 -2.3 -3.2 -2.5 -2.7 -2.5 -4.2 -4.9 -4.7 -4.1 -3.4 ua uil 77 0.0 -1.4 -1.5 -1.6 -1.6 -1.5 -2.7 -3.5 -3.6 -3.4 -2.9 Export Prices 42 0.0 .7 .6 .6 1.2 1.2 1.I 1.5 1.1 .9 .5 Export mand Recession 43 0.0 -.1 -.3 -.3 -.4 -.5 -.5 -.7 - -.8 -1.0 -1.1 Factor SWrvires L Transfers Inflation 51 0.0 .0 .0 .0 .1 .1 .1 .1 .1 .1 .0 kmad 52 0.0 .1 .3 .6 .9 1.0 1.6 2.0 1.4 1.1 1.0 NO-factor Servi ces Inflation 49 0.0 .0 .0 .0 .0 .0 .0 .0 .0 .0 .0 Beand 49 0.0 -.0 -.0 -.0 -.0 -.0 -.0 -.0 -.0 -.0 -.0 Interest Rates 53 0.0 .0 .0 .0 -.0 -.1 -.1 -.0 -.0 -.1 -.2 TUTAL 56 0.0 -1.5 -2.5 -1.5 -.9 -.B -2.0 -2.0 -3.0 -3.2 -3.2 djustaat to Shocks Export Effort SDoés 44 0.0 .2 .9 1.7 1.1 1.3 1.7 1.2 1.3 1.4 1.5 Non-Factor Services 50 0.0 .2 .3 .3 .6 .5 .7 .8 .6 .6 .7 Import Substitution 47 0.0 .5 1.2 1.3 1.2 .6 -.0 -1.1 -.1 .1 .4 oi gil 79 0.0 .1 .3 .3 .3 .3 .0 -.2 .8 1.2 1.7 EDP Slodmm 46 0.0 .2 -.2 -.0 -.4 -.6 .1 -.2 -.4 -.3 -.5 §/m uil 79 0.0 .1 -.1 -.0 -.1 -.2 .0 -.1 -.2 -.1 -.2 TUTAL 57 0.0 1.0 2.1 3.3 2.5 1.8 2.4 .7 1.4 1.9 2.1 Het Cur. Act. Adjust. - 59 0.0 -.5 -.4 1.7 1.6 1.0 .4 -1.4 -1.6 -1.4 -1.1 Current krcount Deficit Counterfactual 62 -1.1 -.9 -1.0 -.9 -.8 -.7 -.6 -.5 -.4 -.3 -.2 Actual 63 -1.1 -1.4 -1.4 .0 .8 .3 -.2 -1.8 -2.0 -1.7 -1.4 -(58462-631 67 0.0 -.0 .0 .0 0.0 .0 -.0 .0 0.0 -.0 0.0 Additional Financing 65 0.0 .5 .4 -1.7 -1.6 -1.0 -.4 1.4 1.6 1.4 1.1 ol. Grants . 54 0.0 .1 .5 .4 .3 .3 .3 .4 .3 .3 .2 C/A Aj * Financing 69 0.0 1.5 2.5 1.5 .9 .8 2.0 2.0 3.0 3.2 3.2 bet C/A dj + Financing 66 0.0 -.0 .0 .0 0.0 .0 -.0 .0 0.0 -.0 0.0 Gross Douestic Product 22 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 Source: Staff Estiamtes. -41- Table I.C.2 Table INDISAI-2 INDIA: StructuraZ Adjustment Analysis - 1ecOMPOsitin, 1973/74-190314 (l55 aillion or as indicated) 1973174 1974/75 1975/76 1976177 1977178 1978179 1979/80 1930181 1981182 1982/83 1983134 External Shocks Price - net of foct 55 G.0 -i,363.7 -2,209.2 -1,610.2 -1,525.3 -1,591.4 -4,058.2 -5,53.2 -5,t6.3 -5,591.2 -5,335.6 Import Prices 45 0. -2,002 -2,740.3 -2,246.7 -2,927.5 -3,015.6 -5,552.0 -7,9023 -7,773.2 -6,925.0 -6,25.0 aim oil 77 0.0 -1,205.8 -1,281.3 -1,406.6 -1,624.3 -1,791.7 -3,628.3 -5,619.9 -6,009.3 -5,832.6 -5,378.9 Export Prices 42 0.0 636.5 531.1 566.5 1,302.3 1,424.2 1,493.8 2,369.1 1,896.8 1,333.8 9138.5 Export Demand Recession 43 0.0 -71.1 - 299.1 - 289.0 - 451.2 - 593.3 - 705.1 -1,093.5 -1,38.1 -1,760.9 -2,062.4 Factor Services & Transfers Inflation 51 0.0 30.7 26.7 29.6 70.6 90.4 87.4 143.4 119.6 86.0 61.0 iemad 52 0.0 114.9 292.2 557.4 975.6 1,193.5 2,148.3 3,292.0 2,299.7 1,929.6 1,752.0 Non-f actor Services Inflation 49 0.0 12.6 10.9 12.1 29.0 32.9 35.7 58.7 48.5 35.2 25.0 1euand 49 0.0 -5.8 -12.6 -17.1 -26.5 -34.6 -41.3 -59.9 -67.0 -78.9 -69.9 Interest Rates 53 0.0 4.4 14.2 8.2 -9.5 -61.9 -98.5 -78.4 -67.2 - 168.7 - 239.9 TOTAL 56 0.0 -1,278.1 -2,177.0 -1,378.0 - 937.0 - 964.4 -2,621.7 -3,281.0 -4,931.9 -5,548.9 -5,939.9 Adjustmeant to Shocks Export Effort Goods 44 0.0 142.9 729.7 1,493.5 1,185.4 1,531.2 2,192.8 1,064.3 2,207.5 2,429.7 2,67 0 Hon-Factor Services 50 0.0 139.0 236.5 285.9 593.4 616.4 928.7 1,233.5 979.1 1,014.9 1,361.6 Import Substitution 47 0.0 398.5 1,027.0 1,26.5 1,205.1 692.9 -41.7 -1,729.2 - 201.2 252.3 779.2 olw oil 79 0.0 61.9 296.5 245.5 35B.8 402.4 55.7 - 306.1 1,297.9 2,059.3 3,060.0 GDP Sloudown 46 0.0 201.9 - 199.8 -21.7 - 399.4 - 699.9 81.9 - 313.5 - 654.2 - 504.2 - 982.3 oll Oil1 78 0.0 50.6 -43.5 -5.6 - 103.3 - 182.9 29.6 - 137.8 - 298.0 - 231.3 - 427.9 TOTAL 57 0.0 882.3 1,903.5 2,944.1 2,594.5 2,151.6 3,161.7 1,055.1 2,331.1 3,192.7 3,934.5 let Cur. Act. Adjust. 5B 0.0 - 395.8 - 373.5 1,566.2 1,647.4 1,197.2 540.0 -2,226.0 -2,600.8 -2,356.2 -2,105.4 Current Account Deficit Counterfactual 62 - 800.0 - 823.2 - 938.5 - 845.2 - 841.4 - 925.2 - 794.0 - 745.0 - 675.2 - 590.9 - 457.6 Actual 63 - 300.0 -1,217.0 -1,213.0 721.0 806.0 35B.0 - 254.0 -2,972.0 -3,276.0 -2,937.0 -2,563.0 -(51+62-63) 67 0.0 -2.0 1.0 .0 0.0 4.0 -.0 1.0 0.0 -.0 0.0 Additional Financing 65 0.0 393.8 374.5 -1,566.2 -1,647.4 -1,193.2 - 540.0 2,22.0-2,600.8 2,356.2 2,105.4 ohr Grants 54 0.0 111.3 439.5 334.6 339.6 381.5 424.3 595.1 479.7 441.3 391.7 CIA Adj * Financing A 0.0 1,276.1 2,178.0 1,379.0 937.0 968.4 2,621.7 3,292.0 4,931.9 5,54.9 5,939.9 Net CIA Adj + Financing 66 0.0 -2.0 1.0 .0 0.0 4.0 -.0 1.0 0.0 :-.0 0.0 Gross Domestic Product 22 75.651.4 97,261.3 85,611.9 89,495.5104,682.9183,827.7132,578.0161,522.9166,513.6170,762.4183,427.1 Source: Staff Estimates. -42- Table I.C.3 Table SICKI-3 IMIA: ShockslAdjustunl Analysis - Details, 3174-19M5/4 W55 million or as indicated) 1973/74 1974175 19M5/76 19177 19778 197817 199180 1980/81 1991182 1982183 199315W - - laports - - Total Background Price Index Actual 12 100.0 151.4 170.0 159.9 174.2 179.4 232.3 278.3 274.3 257.5 245.2 Trend 13 100.0 103.0 106.1 109.3 112.6 115.9 119.4 123.0 126.7 130.5 134.4 Volume Index Actual 80 100.0 93.6 94.8 92.7 303.2 118.7 122.5 145.6 139.5 139.7 143.1 StEt 15 100.0 103.5 107.1 110.9 !14.0 118.8 122.9 127.2 131.7 136.3 141.1 GaEt 14 100.0 100.2 109.9 111.2 120.5 128.4 122.0 130.0 137.6 141.2 151.1 Value Pt6tEt 16 4,000.0 4,264.2 4,545.9 4,846.1 5,166.2 5,507.4 5,871.2 6,259.0 6,672.4 7,113.1 7,82.9 PaCtEt 17 4,000.0 6,266.4 7,286.2 7,092.8 7,W3.7 9,523.0 11,423.2 14,161.3 14,445.5 14,038.1 13,936.9 PaaEt 19 4,000.0 6,064.5 7,476.0 7,114.5 9,393.1 9,211.9 11,341.3 14,474.8 15,09.6 14,542.3 14,319.2 Actual 19 4,000.0 5,666.0 6,449.0 5,928.0 7,18B.0 B,519.0 11,393.0 16,204.0 15,301.0 14,290.0 14,040.0 Dil Background Price Index - Actual 75 100.0 443.6 455.9 480.2 526.6 557.0 992.5 1,430.7 1,461.0 1,391.9 1,249.3 Trend 13 100.0 103.0 106.1 109.3 112.6 115.9 119.4 123.0 126.7 130.5 134.4 Volume Index Actual 76 100.0 95.6 90.9 96.3 100.6 107.2 120.4 136.3 111.9 97.6 79.5 6tEt 15 100.0 103.5 107.1 110.9 114.9 118. 122.9 127.2 131.7 136.3 141.1 GaEt 14 100.0 100.2 109.9 111.2 120.5 129.4 122.0 130.0 137.6 141.2 151.1 Value Pt6tEt 72 342.0 364.6 3B.7 414.3 441.7 470.9 5020 535.1 570.5 60B.2 64L3 PaBtEt 73 342.0 1,570.4 1,670.0 1,920.9 2,066.5 2,262.5 4,130.3 6,225.1 i,579.8 6,441.0 6,027.1 PaGaEt 74 342.0 1,519.8 1,713.5 1,926.5 2,169.8 2,445.4 4,100.7 6,362.9 6,977.8 6,672.3 6,455.0 Actual 71 342.0 1,451.0 1,417.0 1,591.0 1,911.0 2,043.0 4,045.0 6,669.0 5,590.0 4,613.0 3,395.0 Source: Staff Estintes. -4э- , «• sBr�. r т.ые i.o.4 � 1MD1A: SHOCNS/ADJUSTl1ЕПТ А11АСУ515 i16f M1LL10N1 1TEf! 19Т/74 l974l15 1975/76 191ЬR1 1977Л8 191Вl14 1414/00 14В0/01 1981l82 19В2/013 1983/81 EIP-W1 1 1 100.0 I12.0 I21.3 i2+1.B I46.6 151.8 155.3 11I.S 16В.1 1S8.I [52.5 EIF-WI[зZ 2 100.0 10.i.0 106.3 10�3 112.b 1IS.4 114.4 123.0 12b.T 130,5 131.4 6DPr1-TREND i 3 100.0 10В.5 117.7 127.J 136.6 150.4 163.1 1Л.0 142.1 I08.4 ц6.1 БDР�i-йП 1 4 100.0 100.Т 100.Ь 105.2 104.0 113.0 114.6 I21.б I2b.1 126.6 129.5 EIF 01 бtEt S 100.0 103.8 108.0 112.5 117.4 122.7 1I0.4 131.1 141.4 148.В 156.1 EIF OI 6�Et Ь 100.б 1�.0 100.4 105.4 107.4 110.8 111.4 11S.б 115.9 111.1 115.0 EIP У Pt6tEt 7 3,235.0 �.4fw.8 3,710.3 5,981.0 1,27В.5 4,605.9 4,466.5 5,361.1 5,802.9 6,207.4 б,823.0 E1F У Pi6tEt 6 3,139.0 4,10�.3 4,241.1 4,S17.S 5,580.8 6,030.1 b,160.3 7,733.2 7,649.7 1,621.2 7,741.4 EIP V Pa6:Et 9 3,239.0 4,031.1 3,942.3 4,299.5 5,I29.6 5,446.8 5,]55.2 6,639.1 6,311.5 S,B60.3 5,Ы9.О EIP v �пs 1 1а з,Т9.о �,174.о 4,ьп.о 5,753.о ь,31S.о ь,978.о 7,94е.о е,504.0 e,s14.o е,г9о.а в,т55.0 EIP• f ut 11 з,234.0 3,421.7 3,Br2.1 4,608.9 4,301.5 4,597.7 5,117.2 1,79b.3 3,ОЬВ.3 S,24i.T 5,419.3 I1SR UцI : 1 12 100.0 151.4 110.0 ]54.4 174.2 179.4 232.3 Z18.3 274.3 15I.5 245.2 1MF WI 3Z !3 100.0 10J.0 106.1 104.3 112.6 115.4 ]14.4 123.0 126.7 130.5 I34.1 611Р' 0I � l 1й l00.0 100.2 109.4 11I.2 120.5 12В.4 122.0 130.0 131.б 141.2 1S1.I I1�If�.5zr�1.o 15 1оо.о 1a.s 1aT.I 11о.9 114.8 11е.е 1n.9 I2т.г 1т1.7 13ь.т 141.1 iio' V PtбtEt 16 �,000.0 4,2Ы.2 4,545.9 4,В4Ь.1 5,166.2 5,501.4 5,811.2 b,254.0 b,б7Z.4 7,113.1 T,S82.9 INF У Рд6tЕ! I1 4,000.0 6,266.4 7,28b.2 7,092.В 7,493.7 8,523.0 11,4�.2 14,161.3 14,445.5 14,03В.1 13,B3b.9 гМF и Р��тЕt IB 4,110U.4 Ь,0Ы.5 Т,4Т6.О T,114.5 8,393.I 9,2lI.9 11,34I.3 ]4,4Т4.8 15,499.8 11,512.3 14,014.2 lMF V actf 1 14 4,000.0 5,Ь66.0 6,414.0 5,918.0 7,188.0 В,519.0 11,303.0 16,204.0 15,301.0 14,290.0 14,010.0 IM У tPi6�E 20 4,000.0 3,85;.6 1,ОТ.5 4,050.3 4,645.5 5,504.8 5,850.5 i,1Ы.8 Т,ОЬ7.5 7,240.7 7,694.2 6DF�pi6 70R11 t 21 423.7 424.4 465.7 471.2 510.5 543.4 517.1 551.0 5В3.2 598.2 W0.1 6DРвр USs M1s 1 22 75,b51.4 87,261.В В5,б11.4 84,495.5104,682.9118,BZ7.7132,S78.O1Ы,522.416b,513.6110,76Z.4183,1Z7.1 EOPsp Сиггеnт t 23 589.4 б4д.б Т40.8 АОО.О 896.4 975.1 1,O10.7 1,214.4 1,486.8 1,Ы4.1 1,B91.S 6DP IPD(b7017i1t 24 it4.I 161.0 159.1 iб9.В 175.6 174.3 207.1 23].1 254.9 711.В 295.5 P.SRV дАСТ ! 25 -.0 -.О -.0 -.0 -.0 -.0 -.0 -.0 -.0 -.О -.О IRATE Rsli 2Ь 7.8 8.0 6.7 8.4 В.Ь 9.� В.1 7.9 В.9 4.6 10.3 Mr-S Pt6#Et 27 61.0 бВ.2 ТЬ.2 Bi.1 45.1 106.I ]1В.В 132.8 148.4 165.9 185.4 1lF5 Р�Б#Et 2В Ы.0 ВО.7 87.1 47.I f24.1 139.2 1Я.б 191.5 196.9 �01.0 210.3 МгS PiбiEt 24 61.0 15.0 Т4.5 В0.1 97.6 104.б 1l3.3 131.5 129.9 I22.1 120.4 KF5 i(�tt1 t 30 Ы.0 211.0 311.0 366.0 691.0 7Т1.0 ],042.0 1,365.0 1,109.0 1,137.0 1,182.0 F5 Pt6tEt 31 149.1 '166.6 186.2 208.1 Z32.6 254.4 240.5 324.6 362.0 405.4 1r3.1 F5 P�fitEt 32 1й4.I 197.3 212.9 237.7 303.4 ц0.3 3Л.В 4b8.0 4BI.3 491.4 514.0 FS PiWEt � 749.1 183.1 1В2.0 145.8 238.б 255.б 216.4 3I1.5 317.5 Т48.5 291.3 Pvt fr�nsf f 1 31 15В.0 ?�.О 470.0 69Z.0 1,07].0 1,180.0 1,832.0 2,Т71.0 2,1"а;.0 2,453.0 2,500.0 IЬ'TEREST Bt; S5 Z50.1 257.б 265.3 273.3 281.5 289.4 240.6 т07.6 316.0 цб.3 336.1 1ЧТЕR_'ST t�ctl !,;b 254.I 253.2 251.1 2b5.I 291.0 351.B 387.' 38д.0 3В1.0 445.0 62б.0 6Rйk'15 Bl3I 17 91.0 4�.7 46.5 99.4 102.4 105.5 100.Т 11I.9 115.3 118.7 I2Z.3 6R�'Т5 tцtl t ;8 91.0 ZO5.0 536.0 434.0 441.0 4В1.О 533.0 707.0 545.0 360.0 514.0 P.SVCEMtPt6tE 39 -.0 -.0 -.0 -.О -.0 -.0 -.0 -.0 -,0 -.0 -.0 RSVCdlsaPt6tE 44 -.0 -.0 -.0 -.0 -.0 -.О -.0 -.0 -.0 -.0 -.0 P.�iV<d1i�PtStE 41 -.0 -.0 -.0 -.0 -.0 -.0 -.0 -.0 -.0 -.О -.0 SHK I price 4� 0.0 638.5 531.1 566.5 I,302.3 1,424.2 1,443.8 2,ЗЬ4.1 1,Я96.В 1,333.В 91В.5 Sta: I deeand 43 0.0 -TI.I - 299.1 - 28В.0 - 45I.? - 583.3 - 705.1 -1,093.5 -1,ЗВ8.1 -3,760.8 -2,062.4 ADJ I effort 44 0.0 14Z.4 п9.7 1,193.5 I,18S.4 ],331.2 2,142.В 1,86;.3 2,207.5-�l,429.7 2,ЫЬ.0 5ё� б price 1S 0.0 -2,OQ'I.2 2,740.3 -2,246.7 -2,82).5 -3,015.6 -5,5�.0 -7,90Z.3 -1,713.3 ,Ь,425.0 -b,254.0 йW М qrorth 46 0.0 101.4 - 189.8 21.7 - 344.4 - 688.4 6].9 - 313.5 - 651.1 - 304.2 - 982.3 ADJ М suбs 41 0.0 398.5 1,027.0 I,18Ь.5 1,205.1 64I.4 -41.Т -1,п9.2 - 201.2 �2.3 719.2 510: iiFS price �!В 0.9 12.6 10.9 1?.1 24.0 32.4 35.7 �.1 48.5 35.2 25.0 SNi: NF5 дев 44 0.0 -5.8 -12.6 -17.1 -26.5 -34.b -i1.3 -54.9 -67.0 -78.9 -04.9 ADJ 1�5 tffort 50 0.0 139.0 Z3Ь.S 28r.9 593.4 Ыб.4 928.7 1,233.5 919.1 1,014.9 l,3Ы .Ь ) SNDC1:0 -44- - ТаЫе I.�.4 (contd) IRDIA: S80CKS/ADJUSTNEЧT ЯNAIYSIS 11156 MILLION) !1Еlf 1973/1� 1974П5 i415/16 t476/77 1977l7В 197g/79 1919/В0 1980181 19В1/В2 I9B2lВ3 19В3/84 5ИК FSY prict 51 0.0 30.7 26.7 29.6 74.В 80.4 87.4 143.4 118.6 ВЬ.О 61.0 SNK FSY roI 52 0.0 114.9 241.2 551.4' 975.6 1,i43.5 2,14В.3 3,Z82.0 Z,249.7 1,929.6 1,752.0 ВНК IqT 53 0.0 4.4 14.2 $.2 -4.5 -61.9 -ВВ.S -78.4 -Ы.2 - 16В.7 - 2В4.9 � ADJ БRANTS ц 0.0 111.3 439.5 334.6 338.6 381.5 424.3 595.1 474.7 441.3 341.7 Si1K IM PRICE 55 0.0 -1*365.7 -2,209.2 -1,6В0.2 -I,525.3 -1,54I.4 -4,05В.2 -`r,533.2 -5,В7Ь.3 -5,541.2 -5,335.6 SИК TOTAL 56 4.0 -1,278.1 -2,177.0 -1,37В.0 - 437.0 - 964.4 2,b21.7 -3,281.0 -4,931.9 -5,548.4 �5,439.9 А81 - G1R А1С 57 0.0 8В2.3 1,В03.5 1,444.1 2,5В4.5 2,15I.6 3,1Ы.7 1,055.1 2,33I.1 3{192.7 3,834.5 . SHK+ADJ 70TAL 5В 0.0 - 395.В - 373.5 1.566.2 1,б47.4 1,187.2 540.0 -2,22Ь.0 -2,600.8 2,356.? 2,105.4 Тегвs of Тг�де 59 100.0 80.6 71.3 78.0 В4.3 В4.д 6b.4 63.7 Ы.3 61.4 62.2 IWVST r �et� к 60 - 254.а -14в.0 - 21b.o - 1ы.о -е4.о 2.0 2е7.0 59з.о 263.о - 5г7.0 - е6о.0 FSY+MCT-INT i t 61 ]44.1 312.2 505.1 745.1 1,274.0 1,533.8 2,�6.1 3,750.0 2,781.0 2,421.0 2,УЬ6.0 CORBAI cf 62 - ВОО.О - 87.3.2 - В3В.5 - В45.2 - 841.4 - 825.2 - 744.0 - Т45.0 - 675.Т - 580.В - 457.6 t�RBAC f ict i b3 - ВОО.О -1,217.0 -1,2I3.0 Т21.0 806.0 33В.0 - 2�i.0 -2,97Z.0 -3,276.0 -2,937.0 -2,563.0 Ext Brrg VЬРд 64 -.4 1,002.7 1,139.6 1,160.9 1,255.1 1,475.б 1,640.4 1,7Л.8 1,703.1 1,672.4 1,b23.1 ADJ Ext Вгиq 65 0.0 393.В 314.5 -1,566.2 -1,Ь4�Т.4 -1,1В3.2 - 540.0 2,227.0 2,Ьр0.8 2,356.2 2,105.4 NEl ADJ-S1ik. b6 0.0 2.0 1.0 .0 0.0 4.0 -.0 L 0 0.0 -.0 0.0 CAD ciьedr ы о.о �-2.о 1.о .0 о.о 4.0 -.0 1.о О.о :-.о о.о 1`K�►J TOTAL б8 0.0 1,275.1 2,17В.0 1,37В.0 937.0 9b8.4 2,621.7 3,2В2.0 4,931.9 5,548.9 5,939.9 11W t80/81=1001 b9 4�.0 56.4 64.1 Ь�.З 74.b 83.0 47.3 100.0 95.8 94.1 91.3 DIL IMP вt t 70 17,242.0 16,484.0 15,672.0 1b,548.0 17,334.0 18,491.0 20,Т57.0 23,501.0 14,Z89.0 16,В30.0 13,700.0 OIL INPf �ct ! 71 ц2.0 1,451.0 1,417.0 1,58У.0 1,В11.0 2,043.0 4,045.0 Ь,Ьb4.0 5,590.0 4,Ь13.0 3,395.0 OIl IliP У Ptбtc"t 72 342.0 364.b 388.7 414.3 441.7 470.9 502.0 5'S.! 510.� 608.2 b48.3 DIL 1МР У P�6tE# 73 342.0 1,570.4 1т670.0 1,820.4 2,Ob6.5 2,262.5 4,130.3 6,225.I 6,579.8 6,441.0 6,027.I OIL I1IF У PaбaEt 74 342.0 1,514.8 1,713.5 1,826.5 2,164.8 2,445.4 4,100.7 6,36?.4 b,8Л.8 b,67Z.3 b,4�.0 OIL 1NfI f 75 100.0 443.6 45�.8 4В0.2 526.6 .�,7.0 9В2.5 1,430.7 1,461.0 1,3BI.6 1,244.3 OIL QI G 76 100.0 45.6 40.9 96.3 104.6 107.2 120.4 136.3 111.9 97.b 79.5 OIL SFB: PRII•G 77 0.0 -1,205.8 -1,2В1.3 -1,40b.6 -1,b24.B -1,741.7 -3,ЫВ.3 -5,b84.9 -6,009.3 5,В32.В -5,378.8 OIL SNl: DEMp11D 78 0.0 50.6 -43.5 -5.6 - 103.3 - 182.4 24.6 - 137.В - 298.0 - 231.3 - 421.9 OIL 5ИК SltBST 74 0.0 bB.B 246.5 245.5 358.8 402.4 55.7 - 306.1 1,2В7.В 2,054.3 3,060.0 I#1Р' art 80 100.0 93.b � 94.8 92.7 103.2 118.1 122.5 1�5.b 134.5 138.7 143.I Prtnr У dt�Cr80t 81 Ы.4 b7.4 76.5 81.4 В4.2 95.8 100.0 1М.1 10b.1 104.5 113.0 Prtar l dвdFT7�t 82 100.0 111.1 114.8 12В.2 137.4 144.1 154.b 1bб.5 172.4 176.3 1В1.9 IPT DEM IlfF/YEOt 83 100.0 10R.5 100.8 111.4 117.5 124.0 132.0 I34.7 1�.4 132.0 133.3 -45- WORKING PAPER II RESOURCE MOBILIZATION AND PUBLIC EXPEMITURES Prepared by John R. Hansen, with contributions from V. J. Ravishankar and Kiem H. Phan -46- WORKING PAPER II RESOURCE MOBILIZATION AND PUBLIC EXPENDITURES Page No. A. Overview .................................................... 47 B. Current Public Revenues, Expenditures and Savings ............ 51 Tax Revenues ..............................................*** 51 Public Enterprise Net Revenues ............................... 61 Current Expenditures ......................................... 64 Savings .................0..*...............0....0................ 70 C. Public Investment and Structural Adjustment .................. 71 Introduction .... 0 . ...... ............ 71 Growth and Structural Change of Public Investment ............ 72 Implications for Future Public Investment ..................... 75 D. Public Borrowing and Inflation oo.....os....... ... 77 Money and Inflation ................ ....... ... .. 77 Public Sector Borrowed Resources o ..................... 80 Tables II.1 Public Sector .................................. .... 48 11.2 Fi:4nces of the Public Sector ............................. 50 11.3 Government Revenues, 1973/74-1982/83 ..................... 53 II.3a Average Tariffs ...........0............................... 56 11.4 Tax and Expenditure Buoyancies ............................ 58 11.5 Tax Burden and Inflation ... ........................ . ... ... 60 11.6 Public Enterprises Cash Flow .............................. 63 11.7 Government Consumption Expenditures - By Type ............. 66 11.8 Government Expenditures By Sector e....................... 67 II.9 Subsidies From Central Government Budget .................. 68 II.10 Average Annual Public Investment, 1960-70 - 1983/84 ....... 73 II.11 Growth Rates of Money, Output and Prices .................. 78 11.12 Public Sector Borrowing Summary ........................... 81 11.13 Base Money and Its Components ............................. 82 Figures II.1 Money and Prices ....................................... 79 -47- WORKING PAPER II 1/ RESOURCE NOBILIZATION AND PUBLIC EXPENDITURES A. Overview 1. The public sector 2/ in India employs 68% of the labor force and produces 61% of value added in the organized sector of the economy.3/ It has grown over the past three decades, both in absolute terms and in rela- tion to the overall economy (Table II.1). In particulir, the public enterprise sector has grown rapidly, and at a accelerating pace, expanding first in heavy manufacturing industry and energy, then in banking and finance, wholesale trade, light industry, etc. As a result of the industrial policy followed since India's independence, the structure of investment and growth in public enterprises has played a major role in determining the structure and course of India's economic development. At it invests more than it saves, the public sector has always been a net borrower, and as public investment has outpaced public savings, the borrow- ing requirement of the public sector has also grown, both in absolute and in relative terms. This note reviews the current revenue and expenditure of the State and Central Governments, the profitability of central public enterprises, the structural changes over the past decade in public investment, and the mobilization of borrowed resources and its impact on monetary growth and inflation. 2. The financial performance of the public sector improved considerably in the period following the first oil shock. Public savings rose from 3% of 1/ This Working Paper, together with six others, supports the analysis in Chapter 2 of the Report, India: Structural Change and Development Perspectives, Report No. 5593-IN, dated April 24, 1985. 2/ The public sector consists of Government (the administrative apparatus) and public enterprise, which is involved in production of goods and services. Government may be divided into State and Centre local governmental bodies are not included in the statistics presented in this annex). Public enterprise includes both departmental enterprise such as the Indian Railways, that are operated by one of the departments of Government, and non-departmental enterprises. In the accounts presented here, the revenues from departmental enterprises (with the exception of transferred net profits), are excluded from the revenues of the Government. Slight exceptions to this budgetary approach are made, however, when discussing public savings and investment in a national accounts framework. (See Table 11.2). 3/ According to the definition used by the Ministry of Labour, the organized sector accounted for 10% of total employment in 1980/81; according to the definition used in the national accounts, the share of the organized sector in total value added was 33% in that year). -48- GDP in 1971-74 to 5% in 1975-79 (Table 11.2). This was brought about as a result of a significant increase in tax revenuen, accompanied by an increase in the profitability of public enterprises ad well as measures to control the growth of Government current expendituret. The additional measures to mobilize resources for Government contributed to a tangible compression of private consumption relative to CDP during the period. TABLE II.1: PUBLIC SECTOR 1960/61 1970/71 1980/81 Employment as Z of total organized labor force: Government Administration 30.6 32.0 32.5 Public Enterprises 28.1 29.1 35.5 Total Public Sector 58.7 61.1 68.0 Value Added as Z of NDP in the organized sector: Government Administration 21.6 25.3 23.8 Public Enterprises 20.1 27.5 37.2 Total Public Sector 41.7 52.8 61.0 Sources: (1) Ministry of Labour; (2) CSO, National Accounts Statistics 3. The second oil shock occurred in much more unfavorable domestic circumstances, when the Indian economy was beset with acute shortages of agricultural products, infrastructural bottlenecks and a high inflation rate. The current expenses of the Government had increased as a proportion of GDP, while tax revenues were stagnant, and the profitability of public enterprises had declined. India was thus faced with a difficult public financing problem in the beginning of the 1980s. While the strategy adopted in the Sixth Five Year Plan has increased the profitability of some areas of public enterprise (mainly through pricing measures in the energy sector), the Government has not been able to raise tax revenues faster than its current expenses; as a result Government surplus has decreased to less than 1% of GDP. The lessoas of the successful performance of public savings in the earlier period and the difficulties faced during the recent period are discussed in Section B. 4. India's principal response to the two oil price shocks was to increase domestic production of oil, coal and power in order to reduce the heavy burden of oil impuz . This involved a massive increase in public investment in the energy sector. Public investment was also increased in some manufacturing subsectors such as fertilizer, steel and aluminum to -49- substitute for imports. 1/ Increased investment in energy and transport was also required to support the industrial growth and export efforts. Total public investment increased from less than 8% of CDP in 1971/72-1973/74 to nearly 10% in 1975/76-1978/79 2/ and to nearly 12% in 1981/82-1983/84. The public investment strategy in the in 1981-84. The public investment strategy in the context of structural adjustment is axamined and assessed in greater detail under Section C below. 5. The period following the first oil shock was characterized not only by an increase in public savings, but also by a very favorable climate for external concessional assistance, as well as an increased level of mobi- lization of household savings in the form of provident fund and compulsory deposits (forced savings), insurance, small savings, etc. As a result, the dependence on the banking system was reduced to a minimum in this period. In contrast to this, the period following the second oil shock has been characterized by a rapid deterioration in the climate for concessional assistance from abroad. Accompanied by the fall in the Government savings, this has increased the dependence of the Government on the banking system. As the financing of the Government's budget deficit by the Reserve Bank constitutes the major factor determining the rate of monetary growth and the longer term trend of domestic inflation in India, efforts to control the budget deficit have assumed special importance in the 1980s. While the rate of inflation in India was significantly less than the international infla- tion rate 3/ in the period 1973-79, this trend has been reversed since thpn The experience of the public sector in mobilizing borrowed r-:soZQrces from abroad and from the domestic household sector. aad the effect of deficit financing on the rate of monetary growth and domestic inflation are analyzed in Section D. 1/ Although "investment" is an appropriate term when used in the general way it is here, it should be noted that "public investment" in the national accounting sense of capital formation is no, the same as "plan expenditure" which also included some current expenditures on develop- ment programs. This Working Paper will generally speak of public investment when comparisons are made at the aggregate level, for example, to public savings or to private investment. However, because of the way the Government data are presented, discussions at the more detailed level of, for example, sector allocation, will be in terms of Plan outlays. 2/ Since definite policy initiatives accompanied the declaration of "National Emergency" in June 1975, 1975/76 is taken as the first year of adjustment; the period 1975-79 corresponds to the last four years of the Fifth Five Year Plan, and is hence appropriate for analyzing the investment strategy. 3/ As measured by the IBRD index of unit value of exports of manufactured goods from developed to developing countries (HUV). -50- TABLE 11.2: FINANCES OF THE PUBLIC SECTOR (Z of current GDP) 1971/72- 1975/76- 1979/80- 1981/82- 1973/74 1974/75 1978/79 1980/81 1983/84 Government Revenue 14.3 14.3 16.7 17.4 17.9 Government Expenditure 13.4 12.8 14.7 16.0 17.1 Government Surplus 0.9 1.5 2.0 1.4 0.8 Public Enterprise Surplus 2.0 2.3 2.8 2.7 3.9 PUBLIC SAVINGS 2.9 3.8 4.8 4.1 4.7 Government Investment 2.0 1.6 1.6 2.4 2.4 Public Enterprise Investment 5.7 6.6 8.1 8.6 9.3 Fixed Investment 4.8 4.7 6.6 6.9 8.0 Change in Stocks 0.9 1.9 1.5 1.7 1.3 PUBLIC INVESTMENT 7.7 8.1 9.7 11.0 11.7 PUBLIC SAVING GAP -4.8 -4.3 -4.9 -6.9 -7.0 External Sources 1.0 1.4 1.3 1.1 1.3 Domestic Sources 3.8 2.9 3.6 5.8 5.7 Private Sector 0.8 0.5 1.2 1.2 2.0 Bank Credit A/ 3.0 2.4 2.4 4.6 3.7 Commercial Banks b/ 1.3 1.4 1.7 1.6 1.6 Reserve Bank 1.7 1.0 0.7 3.0 2.1 Source: Statistical Annex Table 5.1(b). Notes: (a) This table was derived basically from national accounts rather than budgetary data, though the latter were used in places to help disaggregation (e.g. of Bank Credit). Thus data in this table will not correspond precisely to conventional budgetary data, for example, Local Government is included in Government. (b) The years shown in this table were chosen because of their historical relevance. The period 1971/72-73/74 is a reasonably normal base period prior to the adjustments that followed the first oil shock. The year 1974/75 marked the point by which most post-shock adjustment measures had been put in place. The period 1975/76-78/79 reflects the adjustments that took place by the time of the second shock. The period 1979/80-80/81 was a time when expenditures rose quickly compared to revenues, resulting in a sharp contraction of government surplus. The period since then was one of adjustment (reference Table 11.4). g/ Commercial bank credit (mainly Government securities) is a stable proportion of GDP, as a result of the statutory liquidity requirement (SLR). Reserve Bank credit fluctuates, playing the role of the gap filler. 1k! Includes bank -51- 6. The experience of the public sector in the past decade, in the context of the external shocks and the effort to adjust to these shocks, shows that the future success of India's public investment strategy in terms of achieving the desired economic and social objectives, without fueling inflation and without increasing the dependence on external financing beyond manageable limits, would require (4) appropriate measures to increase tax revenues without increasing the tax burden on the poor, (b) improvement in the operational efficiency and profitability of public enterprises: (c) & concerted effort to control the growth of current expenses of the Government and to make them more efficient, and (d) a sharper focus of the public investment program on the areas of top priority for the public sector and a more efficicnt implementation of this program. These points arc discussed in more detail in the following sections. B. Current Public Revenues, Expenditures and Savings 7. A critical factor shaping the Indian economy during the past decade has been the effort of the Government to generate the savings needed to achieve its key economic objectives. Although the Government has worked constantly to increase its savings in line with the substantial increase in public sector investment that has taken place in the past decade, there has been a widening gap between the two. In the early 70s, the investment/ savings gap was around 5% of GDP; in the past few years it has been averag- ing around 7.0% of GDP. This section focuses on (a) the efforts made by Government itself to generate current revenues, particularly through the tax system, (b) the revenue generation performance of public enterprise, (c) the levels and patterns of current expenditure, and (d) the net results in terms of public sector savings available for investment. Tax Revenues 8. The current income of the Government has risen gradually over the decade, from around 15% of GDP in 1973/74 to over 20% more recently (Table 11.3). The majority of this growth has come through the expansion of tax revenues. 9. About 85% of the expansion of tax revenues (from 12.5% to 16.7% of CDP between 1973/74 and 1982/83) that has taken place as the Government sought to maintain a balance between revenues and expenditure in the face of -52- steadily rising Plan and Non-Plan outlays,1/ has come from the expansion of indirect taxes, which have risen from 10.0% to 13.8% of GDP over the period. Direct taxes have risen only slightly - from 2.62 to around 2.8% of GDP. The heavy reliance on indirect taxes as well (as the structure of these taxes) and the falling share of direct taxes in overall revenues are major issues facing the Government today as it seeks to improve the efficiency and equity of the tax system while assuring that tax revenues at least keep pace with GDP growth. 10. Indirect taxes are clearly the financial backbone of the Government, contributing over 80% of total tax revrnues and, as noted above, the majority of the growth in tax revenue& over the past decade. Of the indirect taxes Levied, about 60% are collected by the Central Government. At the Centre, union excise duties account for over 60% of total indirect tax collections. Although excise :uties have traditionally been the most important source of indirect tax revenues, customs duties have been the most dynamic. 11. The growth of union ecise duties has been slightly faster than that of nominal GDP, as can be seen by the small increase in the ratio of such taxes to GDP in Table 11.3. This does not necessarily mean, however, that excise duties have an intrinsic elasticity greater than unity. They are a mixture of specific and ad valorem rates that have been adjusted regularly to attain a wide variety of economic objectives. Nearly every budget proposes modifications in certain of the rates, and today the structure of these excise duties is quite complex and not always as efficient and equi- table in its impact as might be desired. Out of the total rcvenue from Union excise duties, additional excise duties and cesses, about 90% is contributed by 71 items including, for example, tobacco, motor vehicle parts, electric Fcampings and laminates, petroleum and gas and food products. The remaining 10% comes from several hundred miscellaneous items. I/ Plan outlays include both current and capital expenditures related to the Plan. At the end of each plan period, current expenditures (e.g. for salaries and maintenance) related to investmants under the Plan that have been completed during the Plan are shifted to the non-Plan category. The resulting periodic jumps in non-Plan expenditures are quite misleading and often counterproductive because there is a popular feeling that Plan expenditures are good and non-Plan ones are bad. In fact, non-Plan expenditures are vital to maintaining the productivity of investments made under the various development plans; pressures to increase both the abs,:lute size and relative share of Plan expenditures in the Budget can result in serious adverse eEfects on ongoing activities, thus the Government might well wish to consider abandoning the distinction between Plan and non-Plan in the annual budg2ts. -53- TABLE II.3: GOVERNMENT REVENUES, 1973/74-1982/83 (Percent of GDP) 1973/74 1978/79 1979/80 1982/83 s/ Centre Tax Revenues Direct 2.3 2.5 2.6 2.4 Personal 1.3 1.2 1.3 1.0 Corporate 1.0 1.3 1.3 1.4 Indirect 6.1 8.0 8.3 8.0 Customs 1.7 2.5 2.7 3.0 Import etc. 1.6 2.3 2.6 3.0 Export .1 .2 .1 .0 Excise 4.4 5.5 5.6 5.0 Other .3 .3 .3 .4 Collected by Centre 8.6 10.8 11.2 10.9 Forwarded to States 2.0 2.0 3.2 2.8 Retained by Centre 6.6 8.8 8.0 8.1 Non-Tax Revenues 1.9 2.5 2.3 2.6 Total 8.5 1.3 10.3 10.7 States Tax Revenues 5.9 7.1 8.5 8.6 Own Taxes 3.9 5.1 5.3 5.8 Sales 1.9 2.8 3.0 3.4 Excise & Stamp 0.9 0.9 1.0 1.1 Other 1.2 1.4 1.4 1.2 From Central Government 2.0 2.0 3.2 2.8 Income 0.9 0.7 0.8 0.7 Excise 1.1 1.3 2.4 2.1 Non-Tax Revenues b/ 1.2 1.4 1.4 1.3 Grants from Centre & Other 1.6 2.8 2.3 2.6 Total 8.8 11.3 12.2 12.5 General Government c/ Tax 12.5 15.9 16.5 16.7 Direct 2.6 2.9 2.9 2.8 Indirect 10.0 13.1 13.9 13.8 Non-Tax & Other b/ 2.4 3.3 3.3 3.6 Total 14.9 19.2 19.8 20.3 Note: This table cannot be compared directly to Table 11.2 and related tables because they are based on national accounts concepts of revenue while this table is based on budgetary concepts. The main differences are in the treatment of non-tax revenues of departmental enterprise. a/ To be updated through 1983/84 when data become available. b/ Non-tax revenues at state level include some intergovernmental transactions. Thus the sum of centre and state non-tax revenues is greater than net non-tax revenue of Government. c/ Excluding local governments. Total is equal to sum of States plus Centre less grants from Centre to States and related transfer payments. Source: Statistical Appendix, Section 5. -54- 12. Excise duties have been used as instruments in the adjustment process of the past decade; for example, they were raised on various classes of motor vehicles and on fuel following the first and second oil price shocks to help discourage consumption of petroleum products. Excise duties have also been used extensively to give differential (dis)incentives for production of certain goods and/or production by specific types of firms and in selected areas. Small scale industry in particular is exempted from or given reduced rates on many products otherwise subjected to substantial taxation when produced by the larger firms. 13. At the State level, virtually all taxes are indirect (the collection of direct taxes on non-agricultural income) is reserved to the Centre; only a few States tax agricultural incomes) 11. The performance of indirect State taxes, of which most are sales taxes, has been similar to that of indirect taxes at the Centre - an increase of roughly two percentage points with respect to GDP over the period since 1973/74, of which almost all came through sales tax increases. Overall indirect taxes on domestic transaction have thus risen from 8.3% of GDP to nearly 11Z. 14. The second most important source of revenues for the Central Government are customs duties, which have risen from 1.7Z of GDP to 3.0% since 1973/74. 2F Of customs duties, taxes on imports and related changes are by far the most important, now accounting for nearly 100% of the total, compared to about 90% 10 year ago. During the past 10 yeas, export duties have played a very minor role, except occasionally during periods of very high world prices for products such as tea when the Government has imposed an export tax to capture part of the windfall profits. Efforts by the Government to make Indian exports more competitive in world markets have led to substantial reductions or the elimination of export duties on products such as manganese dioxide and jute goods. 15. To discourage certain categories of imports for the avowed purposes of improving the nation's balance of payments position and stimulating domestic production and self-sufficiency, the Central Government has increased nominal import duties on products such as iron and steel (from an 1/ Of the direct taxes collected by the Centre, 85% after deducting costs of collection and the shares for the union territories are passed on to the States. 2/ Based on gross receipts: data on drawbacks by category are not available. -55- average of 56% in 1977 to 120% in 1982). 1/ (Because of duty exemptions given to various industries on particular products, the average nominal rates would indicate). Import and related customs duties have been the Central Government's most rapidly growing source of revenue since 1970/71, rising from 18% of Central revenues collected to 28% in 1983/84. These duties have grown by about 20% per annum in nominal terms, implying a buoyancy with respect to GDP considerably greater than unity. This, however, is more the effect of the increasing openness of the Indian economy to external trade (at least in current prices) than to rising tariff protection. Imports have risen during the same period by about 20Z per annum in nominal terms, and from 4.3Z to around 10% of GDP. The weight of customs duties collections on imports fell from 30.4% in 1971/72 to 23.5% in 1980/81. They rose again to over 30% in 1982/83, in large measure because of the sharp increase of imports of machinery and equipment and, to a lesser extent, iron and steel, both of which are taxed at average rates that appear to be in the range of 50% over 100%. 2/ It might be noted that part of the reason for the fall through 1980/81 in average import duties has been the fall in the average duty rate on POL, which declined from over 202 before the first oil shock to less than 6% more recently - the result of the Government's having cushioned the impact of world oil price increases by lowering the effective tax yield to the treasury. 16. Because of the extreme complexity of the Indian tariff system, 3/ quantifying the level of and trends in tariffs is difficult. It is further complicated by the Large number of generally partial exemptions from the basic customs duty and auxiliary duties. Nonetheless there is no doubt that the general level is many times higher than typical tariffs in developed 1/ V.R. Panchamukhi, "Indian Tariff Structure - Some Aspects of Structural Change," World Bank, New Delhi,1983. 2/ Exact average rates are difficult to obtain because of the inconsis- tencies between classifications of trade and customs revenue dates. 3/ The Indian tariff consists of: (1) A schedule of basic ad valorem (M) customs duties, applied to the c.i.f. price, (2) Auxiliary duties of 30% or 40% applied to the c.i.f. price, (3) Additional (or countervailing) duties equivalent to excise taxes imposed on local producers, and usually applied as a percentage of the c.i.f. price plus the basic customs duty and auxiliary duty. There are very few specific tariffs. The complexity of the system is mainly due to the very large number of "exemptions" (zero or reduced rates) which must be traced separately for each of the three above components. The most important exceptions are preferential rates on certain products imported from countries with which India has trade agreements and special low rates on particular intermediate or capital goods when used by specific local industries. -56- countries. In an analysis of tariffs (basic plus auxiliary) on 525 items in 1977, the Alexander Committee I found that only about 8Z were less than 40%, 26% were between 40Z and 75%, 38% were between 75Z and 1001, 0.61 were between 100% and 120%, and 27% exceeded 1202. Among the very high tariffs, rates of even 200% and 300% were common, with a maximum of 4501. The Committee felt that the very high tariffs were excessive and recommended a ceiling of 100%, and a maximum for capital goods of 40%. Taking the 3imple averages of the import weighted averages reported by Panchamukhi 2/ for each Customs Chapter gives the following distribution of average tariffe in 1982: Table II.3a: INDIA: AVERACE TARIFFS Average tariff 1982 (Basic plus auxiliary Simple average weighted by imports Number of of weighted chapter in 1981-82 (Z) Customs Chapters averages (Z) 0 - 49 1 22 50 - 100 32 74 101 - 150 11 135 151 - 200 1 170 201 - UP 1 367 46 114 17. Although import duties continue to play an important role in financ- ing Government operations and in the protection of certain industries, India has generally liberalized foreign trade, particularly access to imports. This policy is consistent with its objective of supporting domestic produc- tion and growth with adequate supplies of imported materials, the scarcity of which was a severe constraint to growth in the late 60s and early 70s. Nevertheless, as has been shown by the analysis of the Alexander Committee and others, substantial efforts are needed for further reform and rationalization of the import tariff system so that it can better meet economic as well as fiscal objectives. 1/ Report of the Committee on Import-Export Policies and Procedures (Alexander Committee), Ministry of Commerce, Government of India, January 1978, Table 9, p. 94). 2/ V.R. Panchamukhi: Indian Custom Tariff: Some Aspects of Structural Changes (mimeo 1984). The 46 Chapters were those for manufactured products for which imports were recorded in these years. Chapters 1 to 27 (mainly primary products) and 90 to 100 were not covered. -57- 18. For the States, the most important source of revenues other than State sales taxes is their share of taxes collected by the Centre and dis- tributed according to the recommendations of the quinquennial Finance Commissions, the most recent which finished its work in April 1984. Taxes shared by the Centre with the States declined from nearly 35% of State tax revenues in 1972/73 to 28% by 1978/79. For reasons associated not with the second oil shock but with recommendation of the Seventh Finance Commission, the share jumped back to over 37% in 1979/80, reflecting the adoption of new formula for revenue sharing that increased the share of excise duties and income taxes that were to be passed on from Centre to State. Since then the share has again declined steadily and now stands at 332 of State tax revenues. 19. It is difficult to compare the tax revenue performance of the State and Central Governments because of the very different tax bases given them by law. The Centre is given the right to tax sources of revenue such as non-agricultural income, foreign trade, and major commodities subject to domestic excise taxes -- while the. States taxation rights lie in areas such as sales tax, selected excises, land taxes and stamp taxes. With adjust- ments in tax rates and efforts to increase collections, the States have generally shown a higher buoyancy in their revenzae than has the Centre (Table II.4). The comparison of State and Centre fisctl positions is made even more complex by the very different levels of development and degrees of fiscal need among the States -- and by the fact that Governkantnt has a firm commitment to try to accelerate the growth of the poorer areas. 20. Direct Taxes. Although indirect taxes are by far the most important source of income for the Government of India today, it is often income taxes, both personal and corporate, that excite the most discussion. In quantitative terms direct taxes account for only 22% of total tax revenues collected by the Centre and only 2.4% of CDP. Direct taxes have in fact declined in relative importance since 1973/74, when they contributed over 26% of the taxes collected by the Centre. This decline has come mainly since 1978/79, and primarily because of the falling contribution of personal income taxes, which from a peak of nearly 15% of tax collections by the Centre in 1973/74, have fallen to 8% present. This is largely the result of the variety of fiscal measures that have been taken to relieve the pressure of taxation on lower income groups by increasing the exemption limits and lowering the rates. Other measures, such as exemption for interest income from taxation (with certain limits), have been taken to stimulate the flow of private savings to the banking system. Although direct taxes are equal to less than 3% of GDP, they represent a considerably higher relative burden for the middle and upper urban classes because the burden of personnel -58- TABLE II.4: TAX AND EXPENDITURE BU0YANCIES 1973/74 1978/79 1973/74 1978/79 1980/81 - 78/79 - 83/84 - 83/84 - 80/81 - 83/84 Central Government Revenues 2.05 0.88 1.29 -9.59 1.66 Tax Revenue 2.00 0.79 1.26 -12.08 1.82 Non-tax Revenue 2.37 1.16 1.41 -1.15 1.14 Revenue Expenditure 2.31 1.41 1.83 -3.16 2.11 Capital Expenditure 2.42 1.40 2.08 11.40 0.72 Grants to States 3.17 0.38 1.88 -14.28 1.87 Loans to States 2.89 0.21 2.14 4.22 3.64 States Revenues 2.12 1.39 1.93 4.42 1.43 Tax Revenue 1.82 1.73 2.02 12.10 1.26 Non-tax Revenue 2.05 1.31 1.50 -1.67 1.25 Revenue Expenditure 1.65 1.92 2.00 8.19 1.76 Capital Expenditure 3.35 0.26 2.25 4.68 4.42 Note: These buoyancies have been calculated with respect to GDP from actual receipts and payments and thus reflect policy changes and new measures: in the case of tax revenues this measure is distinct from "elasticities" which are based upon unchanging tax system. Expenditures buoyancies vary more widely than those for revenues because public expenditures are more "discretionary" (i.e. less dependent on GDP) than public revenues. In the last two columns, the performance for the period 1978/79-1983/84 has been disaggregated to show the effects of the substantial reforms which to effect around 1980/81-1982/82. Because of way the regression based calculations work on short time periods, the results are more volatile than for longer periods and may not appear consistent with longer-term trends. -59- income tax is effectively borne only by the non-agricultural sector. 1/ As a percentage of non-agricultural national product, which accounts for about 65% of total product, direct taxes represent about 4%. 21. Although marginal tax rates tend to be very high, direct taxation in India relative to national product is about average by international standards. Direct taxes in low income developing countries in general, for example, were equivalent in 1981 to 2.8% of GDP and to 8.4% in lower middle income countries. 2/ This would indicate some scope for increasing the overall yield of tie direct tax system with appropriate increases as dis- cussed below. 22. The fact that direct taxes have fallen as a percentage of total tax revenues and have stayed more or less constant as a percentage of GDP is evidence that the burden of direct taxes actually paid has not changed appreciably over the years and in fact has declined slightly despite inflation, which often raises effective direct tax rates through tax creep. The Government has continually made changes in the exemption limits and rates that have effectively nullified the overall impact of inflation. The burden has been reduced for both low income and high income taxpayers, and has increased somewhat for taxpayers in the range of Rs 30,000 to Rs 230,000 per year (Table 11.5). For taxpayers in this broad bracket, average rates that formerly ranged from 5% to 47% of gross income now range from 6% to 49%. 31 The most substantial impact was felt by taxpayers earning around Rs 70,000 per year; their average tax increased from 12% to 23% of gross income. At the upper end of the scale, on the other hand, the average effective rates have fallen from 82% to 63%. Overall the effect of the changes has been to reduce the average tax rate on persons earning less than about Rs 23,000 per year and those earning more than about Rs 600,000 per annum, resulting in a structure that has a more even (i.e. Less progressive) distribution of effective rates. 1/ Taxes on agricultural income collected only by a few States have been falling steadily as a share of CDP since Independence; from 0.96% to the current level of about 0.13%. 2/ WDR 1984, p. 270. 31 Incomes are adjusted here in 1981/82 prices to compensate for the effects of inflation. See Amaresh Bagchi, "Inflation and Personal Income Tax: A Note," Economic and Political Weekly, April, 1982, p. 735. -60- TABLE 11.5: TAX BURDEN AND INFLATION gross Income a/ Tax as Percent of Taxable Income (1980/81 prices) 1972/73 1981182 11,700 - - 17,500 2.1 - 23,400 4.0 2.3 29,250 5.3 6.3 35,000 7.1 10.1 46,800 9.5 15.1 70,200 12.3 22.8 117,000 23.8 33.5 234,000 45.7 49.0 585,000 70.7 59.2 1,1707000 82.1 62.6 Source: Adapted from A. Bagchi, "Inflation and Personal income Tax: A Note", Economic and Folitical Weekly, April 1982, p. 735. al Gross incomes are the 1971/72 income tax slab cut-off levels inflated to 1981/82 prices by the consumer price index. Tax in 1972/73 was taken with respect to the original slab rates for that year. 23. The reduction in the very high rates for upper income groups was most certainly desirable. Marginal rates for incomes above Rs 200,000 in the early 70s ran over 94% -- and with wealth tax could exceed 100%. The current maximum marginal rate of around 66% is still unrealistically high and creates incentives to evade taxation and thus feed the black money supply in the economy. Conversely, an average rate of taxation of 23% for people earning gross incomes of around Rs 70,000 per year (which is 23 times the average per capita income and roughly 4 times the average family income) does not seem unreasonable, even though it is substantially higher than the 12% rate a family would have paid 10 years ago on similar real income. 24. Because of the elasticity of direct tax systems such as India's which have rising marginal rates and the ability to tailor direct taxes to provide more equity than is generally possible with indirect taxes, further efforts to increase the share of direct taxes in total tax collections would be desirable. Improvements in collection procedures and more realistic rate structures would help. But the major untapped source of direct tax revenues at present are agricultural incomes. These account for roughly 35% of total national income, but are effectively exempt from direct taxation. While it would not be administratively feasible to impose a general agricultural income tax, consideration could be given to introduction of some form of agricultural income taxation, either direct or using imputed incomes. A -61- generous basic exemption level would focus collection only on the wealthiest of the rural landholders. This would greatly facilitate administration of the tax and would avoid hurting the rural poor. 25. Given the realities of the Indian economic scene, it is clearly not reasonable to recommend scrapping indirect taxes and focusing on theoreti- cally better taxes Therefore adjustments in excise and customs tax rate structures should be introduced to make the system more even in its effect on incentives and easier to administer. 26. A modified value added tax (VAT) appears to be the most promising avenue of action in the longer term. Value added taxes are not cascading and can thus be more accurately tailored to provide an even-handed incen- tives structure. If limited to manufactured articL2s (and perhaps services in the modern sector such as luxury hotel accommodation), a VAT tax should not be more complicated to administer than the present excise tax system. Being essentially more equitable and transparent, would be less prone to corruption. Also, a VAT is to a certain extent self-enforcing, for each party down the line will make certain that taxes on earlier stages of production have been duly paid and receipted so as to minimize his own tax liability. A VAT could be combined with special excises on consumption of luxury goods and services to make the tax more progressive. 27. The possibility of introducing a VAT in India has been under discus- sion for a number of years (ref. the Jha Report of 1978/79). Given the present atmosphere of reform and simplification of administrative controls and procedures, this may be a very opportune time to reconsider these proposals. In fact, India has already made significant progress in this direction by providing for excise tax exemptions with respect to the content of products that has already been taxes at an earlier stage of processing. Thus the shift to a modified VAT would be an incremental rather than a radical process. Public Enterprise Net Revenues 28. Non-tax revenues of Centre and State Governments as measured in the national accounts were equal to about 5% of GDP in 1983/84 1/ Virtually all non-tax revenues of the Government are either non-departmental public enterprise surpluses that are transferred to the Government budget for the net earnings of departmental enterprise. In addition to the share of the public enterprise surpluses that directly benefit the Government budget, part are retained by the units for their own use. Overall public sector earnings in the form of public enterprise surpluses have risen from an 1/ Budgetary non-tax revenues, which exclude, for example, imported revenues from irrigation, were about 3.6% GDP in the same year. -62- average of about 2% of GDP in the early seventies to around 4% of GDP in more recent years. 11 29. While this is a welcome development, these figures conceal widespread inefficiencies in the public sector enterprises. The cash flow 2/ of the oil and banking sectors mask the minimal profits and substantial losses of other segments of public enterprise (Table 11.6). In 1982/83, for example, 70% of the cash flow earned by manufacturing public enterprise companies came from the petroleum sector. The remaining sectors, which account for 77% of capital employed, contributed less than 30% of cashflow. Public sector consumer goods industries have done particularly pqorly in recent years, turning in a gross rate of return ranging from -6% to -12% (these are included in "Others" in Table 11.6). Although goods-producing enterprises generated an overall gross rate of return of 15% of capital employed in 1982/83, if one excludes the 46% rate of return made by the petroleum sector, the rate of return for the remaining public sector enterprises was only 5.5%, and this is on historical book value of assets, which substantially under-values the denominator in this calculation. 30. In terms of net profits after depreciation and interest, and looking more widely to include State enterprises as well, the worst performances came from steel (Rs 1,736 million), mining and heavy engineering (Rs 220 million), metals (Rs 59 million), chemicals and pharmaceuticals (Rs 15 million), and the State Electricity Boards (Rs 1,215 million). 3/ 11 See Table 11.2. Surpluses are defined there as a residual -- public sector savings, less savings of Covernment net of property income deriv- ing from public enterprises. In effect this is an estimation of profits net of taxes (which show up as Government revenue and thus contribute to overall public sector savings). However, as they are calculated on the basis of gross national savings, the surpluses include depreciation and do not represent net profits. While most non-tax revenues come from this source, by no means all public enterprise surpluses are passed back to State ad Centre Governments. 2/ Cash flow here is profits before income tax and depreciation. 3/ Based on data from Annual Report of the Bureau of Public Enterprises. This is perhaps a better indicator of the profitability of public enterprises because it deducts depreciation and interest. And while it can be argued that interest is a return on capital that should be included with profits, on the other hand the depreciation allowance is almost certainly underestimated because the assets are valued at his- torical book cost. -63- TABE I1.6 Public Enterprises Cash Flow Rate of Return on Capital Eaployed I Capital Employed First Adjustment Period Second Adjustment reriod (I share) 73174 03184 72-75 75/76 76/77 77/78 79-90 N/Il 91/982 92193 83/94 A. Total Nanufacturing Enterprises 71.4 62.7 5.75 7.60 8.76 5.01 6.19 6.64 12.49 14.72 13.40 Nanufacturing nc. petrl. 62.7 45.8 3.74 5.52 6.38 1.57 3.26 4.49 5.55 5.53 2.13 Steel 23.7 10.0 2.03 3.94 5.92 2.52 4.90 4.01 4.50 1.83 -2.46 Nimeralu & Netals 10.5 8.5 -1.06 1.36 2.23 -4.37 -4.37 6.93 6.46 5.20 -4.09 Patroleum 9.7 16.9 21.10 26.07 26.09 52.50 20.28 14.07 38.12 46.01 44.23 Chemicals & Pharmaceuticals 6.7 7.6 4.17 1.29 1.08 -1.84 1.86 0.25 5.17 6.74 5.31 Engineering Group 20.8 11.7 9.28 11.65 13.05 7.03 9.22 6.22 11.58 11.45 12.93 Others 1.1 7.9 -0.13 2.89 1.90 -0.19 11.54 10.99 -0.95 2.06 -4.41 1. Total Service Enterprises 20.6 37.3 8.79 7.11 10.09 11.38 10.41 10.05 11.26 9.83 9.35 C. Total Running Enterprises 100.0 100.0 6.61 7.42 9.29 7.59 7.85 7.79 12.10 13.06 11.94 Total excluding petroleua 91.3 83.1 5.32 6.15 7.98 5.91 6.41 6.69 7.67 7.25 5.37 Hon: Total (Rs. million) 52710 298960 3785 6685 10276 9147 1152 14179 26544 34650 ;5690 Source: Bureaa of Public Enterprises, Annual Reports /Computed by dividing Gross Profits by Capital Employd. For details of definition of Gross Profits and Capital Employed please refer to footnotes in Statistical Appendix Table 9.7. Note: Decaume of year-to-year fluctuations in profit performance, 3 year average returns have been used "or the base year for each period to facilitate comparisons. -64- 31. Although some public enterprises such as ONGC -- and even some outside thi petroleum sector such as HinCustan Machine Tools -- have been quite successful, it appears that, on average, the public sector plants are so heavily burdened with social responsibilities, such as providing maximum possible employment at good wage rates, that effective management and economically efficient production are difficult to attain. If India is to achieve the rates of growth it seeks -- growth that is vital to meaningful progress in alleviating poverty -- it needs to get much higher rates of productivity out of its public sector enterprises and, in some cases such as power, water and road transport, to charge prices for the goods and services produced so as to adequately cover costs. 32. Public sector enterprises are currently absorbing nearly 50% of the nation's investment each year, but are generating only about 22% of the nation's value added (mining and quarrying, of which petroleum is a major component, accounted for 3.5% of investment ad 3.1% of CDP in 1982/83. 1/ Only part of this divergence can be explained by normal lags in investments coming on line and a slightly rising share of public in total investment. 2/ Improved efficiency in the public sector units is also vital to generating the resources needed by the Government to finance the non-revenue generating activities that are critically needed to attain social development objectives. Without these resources, the Government would have to make increased recourse to inflationary domestic borrowing from the banking system (ref Part D below). It would also need to draw even more resources from the private household sector, which is already saving at very high rates given the average level of per capita income -- household sector savings now cover about 90% of the public sector savings/investment gap. Current Expenditures 33. Government current expenditures have not risen quite as rapidly as public investment during the past decade -- 16.5% per annum vs. 17.1% per annum for investment from 1973/74 to 1982/83. 3/ Such expenditures have risen consideraoly faster than CDP during this period and as a result were equal to 17.5% of GDP in 1982/83 compared to 12.3% in 1973/74. This increase in current expenditure can be analyzed from two points of view -- the nature of the expenditures and their purpose. 1/ Investment data are estimated from 1980/81 data for mining and quarry- ing and 1982/83 data foc investment in primary sector. 2/ A rising share of investment will automatically tend to cause the share of value added to be less than the share of investment, for the average share of total capital stock (which produces the value added) will be less than the marginal share. 3/ Source: Background data for Table 11.2. -65- 34. The overall structure of Government consumption expenditures in terms of the breakdown between consumption, subsidies, interest pr.yments and transfers has shoun remarkably little change during the pant decade (Table 11.7). Most of the absolute increases took place in consumption expenditures, which constitute about 65% of total current expenditures. Within this category, expenditures on operations and maintenance, though absolutely smaller than those on wages, have risen more rapidly -- from around 3% to around 4% of CDP. While this is encouraging given the general shortfalls on maintenance-type expenditures, there is evidence from the Bank experience with various public sector projects that considerable additional efforts are needed to assure adequate operation and maintenance expenditures. 35. Shortfalla in maintenance expenditures may be one of the key reasons for the rising capital output ratio and falling productivity in the Indian economy. The failure to maintain equipment results in its going out of service prematurely, thus lowering output and raising costs. Costs that would otherwise be met through current operating expenditures on maintenance instead become capital expenditures. 36. Among the many reasons for inadequate maintenance, the most impor- tant appear to be that: (a) adequate maintenance requires a discipline and work ethic that has not yet developed adequately among workers and managers in India; (b) capital reserves are not available for replacement of wornout equipment because depreciation allowances are calculated on the basis of historical book values rather than current replacement costs; and (c) ade- quate maintenance requires current operating funds that are not available because of poor financial performance and diversion of funds to new projects, including those financed by external sources. Attention is urgently needed in each of these areas to improve the productivity of the public sector, the financial position of Government, and the development progress of the nation. 37. Government expenditures on wages have dropped marginally as a per- centage of total consumption expenditures (from 64% in 1973/74 to 62% in 1982/83). This has happened despite the fact that public sector wages seem to have been rising in real terms; 1/ thus the decline indicates a real shift to a somewhat higher percentage of non-wage expenditures in the total pattern of Government expenditures, not a decline in the real cost of labor. 1/ The real wage bill per worker, indexed to 100 for 1972/73, fell to 85.8 by 1974/75, but thereafter rose steadily to 116.4 in 1982/83 and to an estimated 127.7 in 1983/84. -66- TASLE II.7: 0OVERNMENT CONSUMPTION EXPENDITURES - BY TYPE (2 of CDP) ITEM 71/72 72/73 73/74 74/75 75/76 76/77 77/78 78/79 79/80 80/81 Public Current Expenditure 13.76 14.10 12.32 12.83 14.04 14.95 14.42 15.27 16.17 15.88 Consumption Expenditure 10.28 9.91 8.65 8.83 9.92 10.26 9.67 9.86 6.40 10.22 Wages Bill 6.14 6.05 5.55 5.89 6.32 6.41 6.18 6.29 6.40 6.40 Centre 2.15 2.08 1.86 2.27 2.42 2.23 2.08 2.03 1.99 1.92 States 3.99 3.97 3.69 3.61 3.90 4.18 4.10 4.26 4.40 4.47 0 & H 4.14 3.87 3.11 2.94 3.60 3.58 3.49 3.57 3.91 3.83 Centre 2.54 2.40 1.88 1.79 2.19 2.28 2.12 2.13 2.34 2.13 States 1.61 1.46 1.22 1.15 1.42 1.56 1.37 1.45 1.56 1.70 Subsidies 0.97 1.15 1.20 1.70 1.51 1.74 1.98 2.26 2.35 2.23 Centre 0.44 0.59 0.74 1.29 1.07 1.28 1.70 1.64 1.72 1.50 States 0.54 0.56 0.46 0.41 0,44 0.46 0.66 0.61 0.64 0.73 Interest Payments 0.62 0.72 0.81 0.49 0.66 0.75 0.94 0.96 0.94 1.17 Current Transfers 1.89 2.31 1.66 1.82 1.94 2.20 2.58 2.20 2.58 2.26 Source: Attachment Table 1. Note: This table is based on national accounts concepts. Thus the totals for current expenditure are not exactly the same as shown in the budgetary accounts. 38. Total development and non-developmental expenditures of Centre and State Governments increased from 14.7% of GDP in 1973/74 to 20.2% in 1983/84 (Table II.8). Of this,nearly two-thirds came from expanded developmental expenditures. 1/ The largest relative increase has been for industry. This sector is now receiving 2.5 times the share relative to GDP that it was a decade ago, reflecting the increased role of public sector industry, but at 0.5% of GDP, its absolute share is still small (this analysis, however, excludes non-budgetary expenditures on investments that take place with funds mobilized by the public enterprises themselves). The largest absolute increases, aside from that in the "other" category, have been for education and public health, with education getting by a substantial margin the largest absolute share. 1/ These include current as well as capital expenditures. See Section C of this chapter for discussion of investment expenditures per se. -67- TABLE 11.8: GOVERNMENT EXPENDITURES BY SECTOR (Z of GDP) 1973/74 1978/79 1983/84 Non-Developmental 8.7 9.3 10.6 Administration & Tax Collection 2.0 2.0 2.1 Defense 2.5 2.7 2.9 Interest 1.7 2.3 2.9 Other 2.5 2.3 2.6 Developmental 6.0 8.5 9.5 Education 2.2 2.7 2.8 Public Health 1.0 1.3 1.7 Agriculture 0.5 0.9 1.0 Industry 0.2 0.4 0.5 Other 2.1 3.2 3.5 Total Net 14.7 17.8 20.2 Source: Statistical Appendix, Section 5. 39. Of the increase in non-developmental expenditures from 8.7% to 10.6% of CDP since 1973/74, the majority has come from the increase in reported defense expenditures from 2.5% to 2.9% of GDP and in interest payments from 1.7% to 2.9% of GDP (Table 11.8). Of these, onLy the latter reflects the structural adjustment process during the past decade, and then only indirectly in the sense that public debt outstanding has increased from Rs 272.7 billion to Rs 1,057.7 billion, in part to help finance the investments that have taken place during the period. 40. Subsidies of various kinds have played an increasingly important (though not always positive) role in India's economic development over the past decade. They have been designed primarily to promote exports, reduce the cost of fertilizers to farmers, reduce food prices to consumers, and foster specific types of industrial development (Table II.9). Overall, budgeted Government subsidies have increased from 1.2% to 2.2% of GDP between 1973/74 and 1980/81 (Table 11.7). Subsidies for export promotion, 1/ fertilizer, food and certain other items are directly budgeted by the Government and have increased substantially over the past 10 years. At the time of the first oil crisis, budgeted subsidies accounted for about 10% of 1/ These are actually duty drawbacks that offset duties paid on imported imports rather than true subsidies. -68- public current expenditures. During 1982/83 they accounted for over 13% of such expenditures, an increase vis-a-vis GDP from 1.2% to 2.4%. Though not large compared to many other areas of Government expenditure, direct sub- sidies are nevertheless significant, both from a fiscal point of view (they are equal to over two-thirds of direct tax revenues) and in terms of the economic incentives and distortions they introduce. TABLE 11.9: SUBSIDIES FROM CENTRAL GOVERNMENT BUDGET (Rs million) 1973/74 1978/79 1983/84 (R.E.) Item Value % Value % Value % Food 2,510 69 5,700 39 8,350 29 Fertilizer - - 3,420 23 10,480 36 Export Promotion 660 18 3,750 25 4,820 17 Interest Subsidy 200 5 590 4 1,980 7 Other 240 7 19290 9 3,280 11 Total 3,610 100 14,750 100 28,910 100 % of GDP 0.7 1.7 1.8 Source: GOI: Economic and Functional Classification of the Cent.al Government Budget. 41. Of the subsidies estimated for 1984/85, the most important are for fertilizer, costing about Rs 18.3 billion (more than 40% of total Central Government subsidies). Food subsidies totalled Rs 10 billion; combined with export promotion and miscellaneous subsidies, the total direct subsidy bill of the Central Government came to about Rs 43.5 billion. 1/ State Government subsidies, largely Zor State Electricity Boards and Road Transport Corporations, raised the grand total to more than Rs 60 billion (about 2.6% of GDP). 42. In addition to these directly budgeted subsidies, the Government provides at least two forms of indirect subsidies - tax expenditures, and covering losses of public enterprises. Tax expenditures -- tax concessions granted for a variety of purposes including the promotion of certain types of industrial development in selected locations, industries involved in export production etc. - are a major reason that the effective tax base in 1/ It is interesting to note that a major share of subsidies are specifi- cally or largely aimed at agriculture: fertilizer, pesticides, interest charges, diesel fuel and power for irrigation. -69- India is not wider and that the tax system is not more elastic. Government committees regularly propose tax holidays and exemption whenever certain activities are to be encouraged -- ranging from deepsea fishing to develop- ment of backward regions. Income tax deductions and exemptions alone are estimated to cost the Government well over Rs 1,750 million -- and this is only on the basis of limited data. 1/ Other work indicates that the total cost of direct tax concession may be 20-25% of actual direct tax receipts. 43. The revenues foregone through tax expenditures are not spelled out in the annual Government budget and thus are not subject to approval by the legislative assembly; once a tax concession is approved in principle, its costs go on without further review -- unless a special commission is designated. 44. The Government also provides indirect subsidies by assisting directly or through loans enterprises whose products are sold below cost. These enterprises are usually obligated to sell at a price determined by the Government, not by market forces, with the result that efficient firms are forced to beg for funds from the Government to survive, and inefficient firms, because of the assumed responsibility of the Government for their plight, are protected from market pressures that would otherwise force their restructuring or clos'2re. Inappropriate pricing that fails to cover reasonable depreciation allowances as well as operating costs also quickly leads to inefficiencies through inadequate O&M expenditures and decapitalization. 45. Subsidies have played some role in the adjustment process, cushion- ing the shocks of abrupt price changes and stimulating various desired forms of economic activity such as the electrification of irrigated agriculture and increased use of fertilizer. But the costs and benefits of these sub- sidies needs to be reviewed carefully to see if, given India's currently strong economic position and prospects, the costs of continuing these various forms of subsidization could not be reduced significantly without serious impact on the Lower income groups, who would be better served by providing them with productive employment opportunities, supported by ade- quate infrastructure. 46. Interest payments are the final category of current Government expenditures that have shown significant changes during the past decade. These have roughly doubled with respect to GDP since 1972/73, rising from an average of about 0.7% of GDP for the period 1972/73-1974/75 to an average of 1.3% for the three years ending 1982/83 (Table 11.7). Interest payments on domestic debt has shown the most rapid increase, rising from 48% to 86% of total interest paid. This reflects the rapid increase in domestic public 1/ e.g. Anand P. Gupta, "Management of Tax Expenditures in India", EPW, November 24, 1984, who puts the estimate at around 25%. -70- debt, the repayment of external loans during the period that had been con- tracted earlier on relatively harder terms, and the substantial concessional assistance that the Government has mobilized in recent yeas as part of its overall adjustment and strategy for adjustment and economic growth. While the total cost of interest payments has increased substantially in percent- age terms, it is still relatively small, accounting for only about 5% of the total Government expenditures. Savings 47. The net result of the trends in public revenues and expenditures discussed above is that the general Government current administrative budgetary savings (excess of revenues over revenue expenditure) which were gradually brought from a negative position in the year before the first oil shock to a surplus of 2.8% of GDP in 1975/76, have been seriously eroded since then, and since 1982/83 have turned negative -- the Government has had to borrow to cover current expenses (ref. Statistical Appendix Table 5.2).1/ This has happened despite the fact that the State Governments have main- tained a current budgetary surplus since 1974/75. (This surplus has, however, been dwindling since 1976/77 in relation to GDP and as of 1982/83 stood at only 0.4% of GDP.) Central Government savings have been negative since 1979/80 and as of 1983/84 were equivalent to -1.4% of CDP. These facts do not, it should be stressed, necessarily indicate where the "blame"Lies for poor fiscal performance. 48. Grants to States in recent years have been equivalent to 2.3Z-2.6% of GDP. Without these transfers, the relative savings pictures of Centre and State would be very different. For a federal fiscal structure such as India has, where there are built in vertical fiscal imbalances because of the legal structure of tax system, it is difficult to suggest whether the fiscal performance on current Government account should best be strengthened at the State level, the Centre, or both. This choice depends heavily on a wide range of essentially political factors. It is clear, however, that if India is to be successful in its goal of continuing to support a very high rate of investment for a country at its income level and at the same time to minimize inflation by avoiding excessive Government borrowing, substantial improvements are needed in the efficiency of resource mobilization and in their use by both Centre and State Governments. 49. As noted above, the financial returns of the public sector enterprises have not been satisfactory when compared to the resources invested in this sector and have been falling over time relative to the 1/ Note that these are budgetary savings as reflected in the Government's fiscal accounts. They cannot be compared directly with the savings of Government from a national accounts point of view or reflected in Table 11.2. -71- resources employed. At the same time, however, with the massive increase in public investment, the level of public enterprise surplus has risen both absolutely and relative to GDP (from 1.8% in 1973/74 to 4.3% in 1982/83). Had it not been for the surpluses of this sector in the last year or two, the public sector as a whole would have had a current budgetary deficit. With these public enterprise flows, however, the public sector has been able to maintain a current savings rates averaging about 4.4% of GDP since the second oil shock, compared with a rate averaging 4.6% of CDP for the period after the first oil shock (Table II.2).l/ 50. This level of public sector savings, which was miintained almost entirely in recent years by the oil sector, was less, than the growth in investment in the public sector, as is outlined in the next section. Therefore, the overall savings/investment gap and thus the public sector borrowing requirement increased substantially, as is discussed in the final section of this note. C. Public Investment and Structural Adjustment Introduction 51. Public investment has been one of the most important policy instru- ments for achieving India's development objectives, including those of structural adjustment, during the last decade. Among the key objectives of recent plans have been the strengthening of the structure of the Indian economy by expanding the scope and benefits of irrigated agriculture and by increasing domestic production of energy. The expansion of irrigated agriculture was undertaken to reduce the variability and uncertainty of agricultural performance due to fluctuations in rainfall. Increased domes- tic production of energy, particularly of petroleum and coal, was sought to make the economy less vulnerable to the shortages and price escalation in international crude oil and petroleum products - including derivatives like fertilizers. Public investment claimed an increasing share of total resources, rising from 7.4% of CDP (at 1970/71 market prices) during the Fourth PLan (1969/70-1973/74) to 9.2% of GDP during the Fifth Plan (1974/75-1978/79) and 10.2% of GDP during the first four years of the Sixth Plan (1980/81-1983/84). 52. The growth and structural change in public investment during 1973-84 is examined in the first part of this section, which looks at India's experience under the Fifth and Sixth Plans against the background of the Fourth Plan. The final paragraphs of this section will consider the implications of this review of public investment in India during the last 1/ The Government indicates in the Economic Survey for 1984/85 that "It is possible that the method of estimating savings has not captured the large surpluses generated in 1983/84 in the oil sector..." (p.2). -72- decade for measures that would improve public investment's contribution to development and growth in the future given the expected scarcity of resour- ces that will make it difficult to substantially increase the share of GDP going into public investment. Growth and Structural Change of Public Investment 53. Public investment increased substantially during the Fifth and Sixth Plans in absolute and relative terms, following Low growth rates during the Fourth Plan and particularly during the Annual Plans period (1966/67-68/69). Estimated total public investment during the Fifth Plan was 48% higher than in the Fourth Plan. The average annual public investment during the first four years of the Sixth Plan was again 40% greater compared with the Fifth Plan annual average, reaching Rs 60.5 billion in 1970/71 prices. 54. During 1980/81-83/84, the share of public investment in total gross domestic capital formation reached 49%, while its share in GDP (at 1970/71 market prices) increased to 10%. This growth in the share of public invest- ment in GDP during the last ten years was partly due to the higher rates of increase of the prices of investment goods relative to those of general prices as can be seen in the following implicit price deflators (1970/71=100): 74/75 75/76 76/77 7J/78 78/79 79/80 80/81 81/82 82/83 83/84 Public Investment 161.0 173.2 173.0 178.1 192.5 222.6 248.2 284.9 318.5 351.3 GDP 164.0 159.1 169.8 175.6 179.4 207.7 231.4 253.0 272.8 303.3 55. The change in the composition of public investment during the last decade, is given in Table II.10. The two major external shocks associated with the oil price increases of 1973-74 and 1979-80 led to an increased emphasis to medium term structural adjustment in India's development strategy. This strategy called for increased domestic production of oil and other energy sources, increased foodgrains, fertilizers production, import substitution in other areas of manufacturing, and increased exports. The most important beneficiary of the inter-sectoral reallocation of public investment during the last decade was the energy sector which by 1980/81-83/84 accounted for about 28% of total public investment or 2.9% of GDP (at 1970/71 market prices). Public investment in manufacturing during the last decade was also given increased emphasis (but more in terms of import substitution than increased energy efficiency). Agriculture's share in total investment fell somewhat, but stayed more or less constant relative to GDP. (In fact, because of the rising ratio of public investment to GDP, -73- TABLE II.10: AVERACE ANNUAL PUBLIC INVESTMENT, 1960/70-83/84 (Percentages based on 1970/71 prices) a/ Percent of CDP Percent of Investment Fourth Fifth Sixth Fourth Plan Fifth Plan Sixth Plan b/ Plan Plan Plan (69170- (74/75- (80/81- 73/74) 73/74) 83/84) Agriculture .9 1.1 1.1 12.2 12.0 10.7 Manufacturing 1.4 1.9 2.2 18.8 21.0 21.7 Energy c/ 1.4 2.0 2.9 18.9 22.1 28.3 Subtotal 3.7 5.0 6.2 50.0 54.9 60.3 Transport, Storage and Communications d/ 2.0 1.9 2.0 27.5 20.7 19.3 Public Administration and Defense e/ .8 .5 .7 10.5 5.5 7.3 Education & Health, etc. .2 .3 .3 2.7 3.0 3.3 Other Sectors f/ .7 1.4 1.0 9.2 15.3 9.4 Subtotal 3.7 4.1 4.0 50.0 45.1 39.2 Total Public Investment 7.4 9.1 10.2 100.0 100.0 100.0 (Rs billion) (30.0) (44.) (60.5) (30.0) (44.2) (60.5) Source: Central Statistical Organization, "Quick Estimates," January 1985, and National Accounts Statistics, January/February 1980 to 1984; and Bank Staff (estimates for 1982/83 and 1983/84 for all sectors, and preliminary estimates for energy for all years). a/ Annual average gross domestic capital formation (GDCF) made by all types of entities in the public sector. b/ First four years of the Sixth Plan. c/ Includes power, petroleum and coal. di/ Includes railways, roads and bridges, other transport and storage, and communications. el Does not include roads and bridges. El Consists of all sectors not elsewhere listed, including forestry, mining other than coal and petroleum, construction, gas and water supply, trade, hotels and restaurants, and banking and insurance. Public investment in trade, hotels and restaurants was unusually large during the Fifth Plan, particularly in 1975/76 and 1976/77 with GDCF of Rs 6.89 and Rs 6.63 billions at 1970/71 prices respectively. The annual average public investment in this sector of Rs 3.37 billion during the Fifth Plan, compared with less than Rs 1 billion during the Fourth and Sixth Plans, accounted for the very large share of other sectors during that plan period. -74- none of the major sectors -- agriculture, manufacturing, energy and tran- sport (except for a very slight drop in the Fifth Plan) -- actually experienced a decline in investment relative to CDP.) The high priority given to energy and manufacturing did, however, imply a corresponding decline in the share of public resources allocated to public investment in transport during the last decade as compared with the preceding decade. 56. Energy. The major increases in public investment in petroleum within the energy sector -- by 98% and 170% in real terms during the Fifth and Sixth Plans over the preceding plan -- clearly reflect the expansion of domestic production of crude oil and natural gas as part of India's strategy to adjust to the oil shocks. During the first four years of the Sixth Plan, the petroleum subsector's share in total public investment in energy was 22% compared with 14% during the Fifth Plan. Average annual investment in coal during 1980/81-83/84 was about 70% higher in real terms than during the Fifth Plan, and the share of coal in total public investment in energy rose to 10% from 12%. Public investment in power also increased substantially during the Fifth and Sixth Plans, but less than investment in petroleum and coal: during first four years of the Sixth Plan, power's share in total public investment in energy decreased from 76% to 66%. 57. Transport. The transport sector's share in total public investment in real terms dropped to about 20% compared with 27% during the Fourth Plan (and 36% during the Third Plan). However, the overall rate of public investment increased such that transport maintained its 2% share of CDP. Investment in the railways, which rose substantially during the first four years of the Sixth Plan, fell in relative terms from 1.5% to 0.7% of GDP between the Third and Sixth Plans. The reduced share for rail reflected the decision during the Fifth Plan to focus on modernization and improvement of the existing rail network rather than its extension. The Sixth Plan emphasized the need to improve the transport sector's energy efficiency (considering that transport accounted for nearly 33% of total commercial energy consumption). Improved energy efficiency was to be achieved through the electrification of the railways, the development of relatively more energy efficient transport modes like coastal shipping, inland water tran- sport and pipeline transportation. 58. At about 0.6% of GDP, the share of public investment in roads during the first four years of the Sixth Plan was about the same as it had been during the Fourth and Fifth Plans, but less than the 0.8% during the Third Plan. In the Sixth Plan, rural roads were to receive an increased share of the State road programs. Also, road transport was expected to move a greater volume of bulk commodities - particularly coal and steel from selected railway terminals for further distribution -- while the railways would concentrate on moving bulk traffic between these selected terminals. 59. Agriculture. In agriculture, a major objective of public investment in the Sixth Plan continued to be the creation of additional irrigation potential - 5.7 million hectares compared with 5.0 million hectares during -75- the Fifth Plan. High priority was given to adequate funding for improving capacity utilization and optimizing the benefits of irrigation including for investment in the construction of field channels and watercourses, and in land levelling and landshaping. Agriculture's share in public investment during the first four years of the Sixth Plan was 1.1% of GDP, the same as in the Fifth, and slightly higher than its share in the Fourth. 60. Industry. An import substitution strategy with emphasis on heavy industry for the public sector has continued to guide investment in public manufacturing industries, which received 21-22% of total public investment during the Fifth and Sixth Plans. High priority was attached to the expan- sion of the steel, fertilizers, machinery and engineering, oil refining and distribution, non-ferrous metals, and petrochemical industries. The rapid development of these core sector industries was considered vital for sus- tained growth. 61. Returns on the public sector's investments in industry have, however, been disappointing in many areas. The emphasis on large-scale greenfield plants has resulted in major implementation delays, which post- pone the benefits and reduce the economic returns. The multiplicity of objectives, the heavy weight given to social objectives (maximum employment at good wages, development of backward regions and provision of goods at lowest possible cost), the constraints on developing a professional manage- ment cadre, and the frequent absorption into the public sector of sick units have made it very difficult for the manufacturing public sector units to earn an economically acceptable rate of return on assets employed (ref. Section B). 62. Social. Education and health have long received one of the lowest shares of public investment relative to GDP -- about 0.3%. In part this reflects the fact that investment is relatively less important than current expenditures in this area (total Government development expenditures on social programs were 4.5% of GDP in 1983/84). Nevertheless there is a critical need for massive investments in areas such as clean water supplies, health clinics, and rural schools, which can have a very direct and positive effect on the lives of those who are desperately poor and who are very hard to help in the short term through more direct income-generating projects. Resources diverted at the margin from massive public manufacturing projects would be well spent in these poverty-alleviating areas, with their long-run demographic benefits too. Implications for Future Public Investment 63. The above analysis indicates that public investment has increased very substantially over the past decade from 7.7% of GDP in 1971-74 to 11.7% in 1981-84. The analysis in the earlier section of this Working -Paper indicate, however, that substantial further increases in the share of public investment in CDP would be very difficult to attain. Savings and taxation rates are already relatively high for a country of India's per capita -76- income. A higher tax ratio would probably increase the disincentives to private production and savings and reduce the resources available for investment by this sector. It would als generate further pressures for tax evasion. 64. Raising the share of public investment in CDP through higher borrow- ing rates would also be difficult for reasons spelled out in Section D below. (Primarily the risk of squeezing the private sector out of the capita market, the inflationary pressures of increaaed Government borrowing from the RBI and the diminishing relative availability of concessional external assistance.) 65. Thus future public investment strategies will need to seek to maxi- mize the developmental impact of public investment expenditure within a relatively constrained share of GDP. The focus will need to be on those sectors which have demonstrated -- and are likely to continue to produce -- highest developmental returns. 66. Based on the above analysis of the past, it appears that energy (oil and gas) investments have been highly profitable, playing a vital role in the nation's development and growth. While some increased private sector participation might be desirable to help alleviate the project implementa- tion and management constraints that the sector has faced in recent years, continued public sector investment in this sector would be very well justified. In agriculture the past experience has been generally very good in terms of reducing the vulnerability of the economy to drought and spread- ing the benefits of development to some of the poorer sections of the economy. Continued investment efforts, especially in minor irrigation and in completion of ongoing projects, hold promise of continued high returns. Transport investment shortfalls have created periodic bottlenecks over the past decade particularly in rail. Efforts to enhance the effectiveness of the transport sector along the lines recommended by the 1980 National Transport Policy Committee need to be pursued further. Public investment in industry during the past decade have been marked by high capital/output ratios, delayed project implementation and low financial returns as shown above and in Working Paper I. In the environment of scarce resources for public investment that will face Government during the Seventh Plan, con- sideration needs to be given to ways to improve the efficiency and produc- tivity of public enterprise and to the possibility of depending somewhat more heavily than in the past on private enterprise to carry the burden of new investments in this sector. The work already done by L.K. Jha in recent yeas is highly relevants here, 1/ and further relevant analysis can be expected from the special committee on public enterprises set up recently in the Prime Minister's Office. 1/ e.g. Economic Strategy for the Eighties. New Delhi, Model Press, 1980. -77- 67. The experience of India in programs for social development during the past decade has been mixed, and the lessons for the future are not entirely clear. However, analysis of poverty related programs in the Economic Report prepared last year by the Bank (ref. especially Chapter 5) and in Working Paper IV of this Report provide useful insight -- including the importance of agricultural growth. The experience of the past decade does indicate, however, that without Government's efforts to spread the benefits of growth through poverty-oriented programs, the status of the poor would have been worae. Social programs will have to remain &n important element of the Government's total expenditure program even in an environment of constrained resourcea. D. Public Borrowing and Inflation 68. In the past decade India experienced two bouts of high inflation, when domestic factors combined with the external shocks to rapid increase in prices -- once in 1972/75 (18.3% annual rate) and again in 1979-8 (17.7%). 1/ dowever, inflation decelerated considerably in 1975-79 to 1.5% a rate well below that of international inflation, and India's export competitive- ness improved in that period, favorably influencing the adjustment effort. The trend in the relation between Indian and international prices was reversed by the second oil price sock; since 1979, domestic inflation has been consistently above international inflation, both during and after the external shock. Given the importance of fulfilling real investment needs in a climate of resource constraints and the critical need to increase export competitiveness, effective measures to control inflation in the medium-term need to be implemented, taking into account the lessons of the past decade. 69. While year-to-year price movements in India are largely influenced by agricultural performance and administered price changes, the longer term trends are determined by monetary variables and external factors. As the most important policy variable that affects base money in the economy, the budget deficit assumes special importance, and control of the budget deficit has been a matter of great concern for the monetary authorities and the Government in recent years. This section reviews the experience of the past decade, the ability of the Government to mobilize borrowed resources from non-banking sources, and the inflationary impact of the budget deficit. Money and Inflation 70. Money and quasi-money (M3) has increased over the past decade from 30% to 44% of GDP (which implies a reduction in the velocity of money). The increasing monetization over the past decade is the result of two factors: 1/ Rates quoted here are on annual average basis, using the wholesale price index. Other inflation indicators are shown in Table II.11. -78- (a) increasing proportion of agricultural produce that is marketed, 1/ and (b) increasing proportion of household savings, especially in the case of rural households, that are channelled into the banking system. While the first factor affects transactions demand and hence narrow money (Ml), the second factor only affects savings balances or quasi-money. The major factor influencing M3/CDP in the past decade has been the second one, reflecting the rapid expansion of banking in the rurrl areas in this period. The trend growth rate of narrow money as a proportion of CDP is only 1% in the period 1971-84; if adjusted CDP is taken as the denominator, deducting the non-monetized portion, then the ratio does not exhibit any growing trend, which reflects the stability of the velocity of money in the long- run. 71. The overall price level in India closely follows the ratio of money supply to real CDP in the long run (Figure 11.1). In periods of acute agricultural shortage, following bad harvest yers such as 1972/73, 1979/80 and 1982/83, the velocity of money shoots upwards, reflecting rising price expectations and the desire of traders to accumulate stocks. Thus, supply shortages play the role of the catalyst that transforms the inflationary potential of accumulated money balances into an active force. TABLE II.11: GROWTH RATES OF MONEY, OUTPUT AND PRICES 1971-75 1975-79 1979-81 1981-84 Money Supply (MIR) 12.7 11.5 16.2 14.7 Real CDP 1.3 6.4 0.6 5.4 GDP Deflator 13.2 2.3 13.6 9.4 Wholesale Prices: Annual ave=age basis 15.0 1.5 17.7 7.1 Point-to-point basis 14.7 2.4 19.0 6.1 Consumer Prices: Annual average basis 14.3 1.1 10.1 10.8 Point-to-point basis 14.9 0.8 12.5 9.9 72. In order to achieve a real growth rate of 5% in the medium term, and contain inflation within 6% (expected rate of international inflation), the growth of money supply would need to be restricted to 11%. If the monetized portion of GDP continues to increase in relative terms as in the past decade and the velocity of money continues to decline, then a 12% growth of money 1/ The monetized portion of NNP increased from 87% to 89. over the past decade, according to the estimates of J.C. Rao, Reserve Bank of India, Occasional Papers, June 1983. Figure II.1 INDIA Money and Pices 325 - 275 - * 225 mY 125 Ve!ocity of Ney ...... .... eg ..... I i i I i i i i i 71 72 73 74 75 76 77 78 74 Z2 FSco Years -80- supply may be permissible. As external reserves-cannot be allowed to con- tinue to fall as they have in recent years, this would require greater effort on the part of the Government to contain the budgetary deficits both in terms of improving the efficiency of resource mobilization and of setting reasonable targets for expansion of both Plan and non-Plan expenditures. This restraint is necessary not only from the point of view of domestic inflation but also in terms of the availability of foreign borrowing and the ability to repay it. Public Sector Borrowed Resources 73. Financial savings oi households in the form of provident fund, insurance, small savings, etc. has been an increasingly important source of borrowed resources for the public sector. This source has been used effec- tively to raise additional resources in both the adjustment periods; in particular, savings of rural households mobilized through the post office savings system, have grown very rapidly, In the first adjustment period, additional resources were also mobilized through the introduction of the 'Compulsory Deposit' scheme, which is a form of forced savings. 74. The growth of public savings from less than 3% of GDP in 1971-74 to nearly 5% of GDP in 1975-79, combined with the increase in external assis- tance from 1.0% to 1.3% of GDP, enabled the Government to reduce its depend- ence on borrowing from the Central bank, which fell below 1% of GDP in 1975-79 (Table 11.12). However the sharp deterioration in the external aid climate after the second oil shock, combined with the expansion in overall borrowing requirements, raised the borrowing from the RBI to over 3% of GDP in 1979-81. In spite of increased non-concessional borrowing from abroad and increased mobilization of household savings, potentially inflationary Central bank borrowing has remained above 2% of GiP since then, which under- scores the importance of concessional aid for India. 75. The relation between the budget deficit, external reserves, the monetary base and overall monetary growth in India are shown in Table 11.13. The effective curtailment of the budgetary deficit in 1975-77 brought down the rate of monetary growth in spite of the rapid accumulation of external reserves. The budgetary deficit accelerated after March 1977, and grew extremely rapidly in the period of the second shock, but the expansionary impact on money supply was partly mitigated by the fall in external reserves. Considering that the growth of money supply has exceeded 12% throughout the past decade, and given the fact that external reserves cannot be allowed to continue to fall, the control of domestic inflation in he medium term indeed poses a challenging task. -81- TABLE 11.12: PUBLIC SECTOR BORROWING SUMMARY (Z of CDP) 1971-72 1975/76 1979/80 1981/82 - 73/74 1974-75 - 78/79 - 80/81 - 83/84 Public Investment 7.7 8.1 9.8 11.0 11.7 Lending to Private Sector 1.3 1.4 1.5 1.7 1.6 Total Capital Expenditure 9.0 9.5 11.3 12.7 13.3 Financed by: Public Savings 2.9 3.8 4.8 4.1 4.7 Borrowed Resources 6.1 5.7 6.5 8.6 8.6 Of which: External Resources (net) 1.0 1.4 1.4 1.1 1.3 Concessional 1.0 1.3 1.3 1.0 0.8 Non-concessional n.s. 0.1 0.1 0.1 0.5 Private Households 2.1 1.9 2.7 2.9 3.6 Provided Fand & Pension 1.3 1.4 1.5 1.6 1.7 Life Insurance 0.5 0.5 0.6 0.7 0.7 Post Office Savings ) 0.3 --- 0.6 0.6 1.2 Other a/ ) Banking System (net) 3.0 2.4 2.4 4.6 3.7 Commercial Banks b/ 1.3 1.4 1.7 1.6 1.6 Reserve Bank 1.7 1.0 0.7 3.0 2.1 a/ Includes Compulsory Deposits from 1975/76 onwards. b/ Includes bank lending to public enterprises. Sources: (i) Statistical Appendix Table 5.1(b). (ii) Table III.1. (iii) CSO, National Accounts Statistics. -82- TABLE iI.13: BASE MONEY AND ITS COMPONENTS 1971-74 1975-77 1977-79 1979-81 1981-84 Contribution to changes in Base Money (%): Budget Deficit 100.4 29.2 38.6 130.9 108.7 External Reserves (Net) 5.4 101.6 66.1 -12.2 -33.6 Other Items al -5.8 -30.8 -4.7 -18.7 24.9 Base Money 100.0 100.0 100.0 100.0 100.0 Annual compound growth rates (2): Budget Deficit 17.3 4.4 10.1 32.1 17.4 External Reserves (Net) 7.6 165.4 44.6 -6.2 -30.2 Base Money 14.7 13.5 19.9 17.5 14.0 Money Supply (MIR) b/ 13.5 13.7 18.1 14.4 Quasi-Money c/ 24.2 26.4 22.4 20.9 Money & Quasi-Money (M3) 17.1 19.2 20.4 17.7 15.5 a/ Includes RBI's credit to banks and non-monetary assets net of non-monetary liabilities; a rapid increase in non-monetary assets accounts for the unusual movement in recent years. b/ Sum of currency and transaction balances, based on revised MIR series derived by J.C. Rao in "Money and Prices - An Empirical Study of the Indian Experience, 1970-1982", RBI, Occasional papers, June 1983. c/ Savings balances or time deposits, equal to the difference between M3 and MIR; this has grown at an accelerated pace since the early 1970s due to the rapid expansion of banking in rural areas following bank nationalization in 1969. -83- WORKING PAPER III FOREIGN TRADE - TRENDS AND POLICIES Prepared by Christopher Hall and V. J. Ravishankar -84- WORKING PAPER III FOREIGN TRADE - TRENDS AND POLICIES Page No. A. Structural Changes in the Balance of Payments - 1973-83....... 85 B. Imot....................... ...... 87 Effects of External and Domestic Shocks..O........O........... Import Substitution............... .. .... ... .*... ...... Import Liberalization ............................ .......... C. Expo rtso............ ................ .... .................. 91 Factors Influencing Export Performance................... 91 Tables III.1 Balance of Payments Trends................................ 86 111.2 Major Trends in Imports................................... 88 111.3 Import Substitution........... ........................ 89 111.4 Imports of Capital Goods and other Manufactures Annual Volume Growth Rates.. ......... ..... ... ......... 90 III.5 Export Growth..... ..... ........... ...................... 92 -85- WORKING PAPER III 1/ FOREIGN TRADE - TRENDS AND POLICIES A. Structural Changes in the Balance of Payments - 1.973-83 1. The first oil price shock of 1973/74 increased the trade and current account deficits from negligible levels to 1.7% and 1.4% of GDP respectively (Table III.1). In the next two years, however, the total volume of exports increased by 10% and 16% respectively; as a result, exports in 1976/77 reached 6.4% of GDP as compared to 4.8% in 1974/75. Secondly, private transfers, particularly workers' remittances from the Middle East, increased unexpectedly giving India an additional source of revenue in the current account. Thirdly, agricultural production picked up, leading to an accumula- tion of foodgrain stocks and reduced need for imports; foodgrain imports fell from US$1.6 billion in 1975/76 to US$100 million inL 1978/79. Fourthly, the favorable response of the international and community to India's balance of payments problems resulted in an increased level and faster disbursements of concessional loan and grant assistance. As a result of these factors, the current account balance showed a surplus in the three years 1976/77-1978/79, and external reserves accumulated to nine months of imports of goods and services, up from the very low level experienced in 1974/75 when reserves covered only two months of imports. 2. The increasing accumulation of foreign ex.hange, and of foodstocks as well, without the need to resort to significant q-uantities of grain imports during this period, went beyond initial expectation. At first such accumula- tion provided the needed replenishment to levels which were extremely low. Later, however, it began to become apparent that the growing reserves reflected an insufficient absorption of available external resources in the Indian economy. Output, investment and consumption could have been higher than they were, without imposing an undue burden on the balance of payments. Indeed the subsequent decline in aid flows to India during 1977/78 to 1979/80 could have partly reflected the perception of dont)rs that despite the accepted aid requirement in India, there was no n:gent need to make the transfer immediately. 3. Under the controlled import regime of the 1960s and early 1970s, India's imports had not increased in volume terms for more than a decade. As external reserves began to accumulate during the 1976/77-1978/79 period, the Government decided to liberalize imports as a meano of (1) easing infrastruc- tural bottlenecks which had crept into the economy and had begun to affect detrimentally domestic production and production for the export market; and (2) fulfilling investment good demand and stimulating investment throughout the economy to absorb the surplus and provide the necessary investment good import base for increasing long-term growth prospects. 1/ This Working Paper, together with six others, supports the analysis in Chapter 2 of the Report, India: Structural Change and Development Perspectives, Report No. 5593-IN, dated April 24, 1985. -86- Table III.1: INDIA: BALANCE OF PAYMENTS TRENDS (Z of GDP at current prices) 1973/74 1974/75 1976/77 1978/79 1980/81 1981/82 1983/84 Exports 4.3 4.8 6.4 5.9 5.3 5.2 4.4 Imports -4.5 -6.5 -6.6 -7.2 -10.0 -9.3 -7.4 Trade Balance -0.2 -i.7 -0.2 -1.3 - 4.7 -4.1 -3.0 Non-factor Services (net) 0.1 0.2 0.4 0.6 0.8 0.6 0.8 Resource Balance -0.1 -1.5 0.2 -0.7 -3.9 -3.5 -2.2 Vet Factor Income -0.4 -0.2 -0.2 - 0.4 0.2 -0.5 Current Transfers 0.2 0.3 0.8 1.0 1.7 1.3 1.3 Current Account Balance -0.3 -1.4 0.8 0.3 -1.8 -2.0 -1.4 Loans & Grants 1.1 1.4 1.6 0.8 1.2 1.1 1.3 (net) IMF (net) 0.1 0.6 -0.4 -0.1 0.6 0.4 0.7 Capital, n.e.i. -0.8 -0.7 -0.2 0.2 -0.2 -0.9 -0.2 Seserve Drawdown -0.1 0.1 -1.8 -1.2 0.2 1.4 -0.4 End-year Reserves (no. of months of imports of goods and services) 3 2 6 9 5 3 4 Source: Statistical Appendix, Standard Table III and Table 3.1. 4. Ia 1979/80, India was again hit by higher oil prices. Crude petroleum and product imports totalled US$4 billion in 1979/80, representing 63% of total domestic consumption. The combined effect of the liberalization on non-oil imports, the sharply higher world oil prices, followed shortly thereafter by global recession which adversely affected export performance, put the balance of payments under increasingly severe strain. The develop- ments were accompanied by the severe drought of 1979/80 and exacerbated by power shortages, which in turn cut back coal production and transport serv- ices and caused drastic reductions in both agricultural and industrial output. However, rather than return to a more inward-looking conservative energy, that would have reduced growth prospects, the Government's response to these developments has been to maintain a flexible import policy which has allowed non-oil imports to increase. -87- 5. The Sixth Plan (1980/81-1984/85) strategy envisaged bringing about a gradual adjustment to the balance of paymants, i.e. maintaining capital goods and intermediate imports at high levels with the exception of trade and current account imbalances while sustaining a higher growth rate through the alleviation of basic infrastructure and supply constraints, reducing depend- ence on petroleum imports, improving efficiency of resource use, promoting export expansion and efficient import substitution, and stepping up invest- ment and savings rates. As a consequence of this strategy, the current account deficit, which reached the level of 2% of GDP in 1981/82, has only gradually declined to more sustainable levels, to 1.7% in 1982/83 and an estimated 1.4% in 1983/84. The trade deficit has fallen since it reached the exceptionally high level of US$7.7 billion in 1980/81; but at US$5.7 billion in 1983/84, it still remains large compared to the period before the second oil shock when it never exceeded US$2 billion. The major trends in the components of the balance of payments over the past decade are discussed in greater detail below. B. Imports 6. Effects of External and Domestic Shocks. In 1973, India along with other developed and developing countries began to face a more hostile exter- nal environment in the form of increased oil prices. India was also affected by increased import prices for several bulk commodities such as fertilizer and steel, which occupied an important place in the total import bill. Further, these external price shocks came at a time when India was facing a serious domestic food shortage. Foodgrain production, which had reached 108 million tons in 1970/71, stagnated thereafter and dropped under 100 million tons in both 1972/73 and 1973/74. Requirements for imports coupled with the doubling of the import price of cereals between 1972/73 and 1975/76 caused the import bill for foodgrains to rise from US$105 million to US$1,552 mil- lion in this period. The combined effect of these adverse factors was an increase of more than two and a half times in India's total import bill (Table 111.2). 7. In the period 1978/79-1980/81, India's import bill once again increased supply, primarily as a result of the second oil price shock. The price of a barrel of oil, which had averaged US$12.9 in 1978, reached US$30.5 in 1980 and exceeded US$34 in 1981. However, the price of other bulk com- modities did not rise as rapidly as during the first shock period. The average import unit value paid by India increased by 53% in 1978/79-1981/82, as compared to 141% in 1972/73-1975/76. In spite of this, the total import bill almost doubled as a result of (a) infrastructural constraints, espe- cially power and coal shortages, which adversely affected capacity utiliza- tion in many industries including steel, fertilizer, aluminum, etc. and increased import requirement, (b) increased volumes of imports of capital goods and industrial inputs consequent to the liberalization of import control, and (c) the high import intensity of investment in some of the import substituting industries, such as petroleum, phosphatic fertilizer, aluminum, copper, etc. -88- Table 111.2: INDIA: MAJOR TRENDS IN IMPORTS (current in US$ million) 1972/73 1975/76 1977/78 1978/79 1981/82 1983/84 Foodgrsins 105 1552 143 106 389 580 Edible Oils 20 16 829 649 700 525 Petroleum at 265 1417 1811 2044 5553 3395 Fertilizer 190 712 441 597 783 279 Iron and Steel 293 360 307 572 1348 910 Capital Goods 691 1080 1297 1497 2219 2693 All Others 859 1312 2360 3054 4309 5658 Total 2423 6449 7188 8519 15301 14040 (Unit Value Indices in US$ terms) b/ Foodgrains 100 195 185 160 172 158 Edible Oils 100 183 228 237 213 206 Petroleum 100 664 701 665 1489 1266 Fertilizer 100 363 178 189 256 177 Iron and Steel 100 117 185 207 236 234 MUV c/ 100 170 187 220 254 238 Total d/ 100 241 247 255 389 348 a/ Net of exports. oi Converted from 1968/69 base. c/ Unit Value Index of OECD manufactured exports, used for deflating capital goods and other manufactured imports. d/ Different from official series due to different deflator for capital goods and other manufactured imports. Source: Ministry of Commerce, DGCIS; World Bank staff estimates for 1983/84. 8. Import Substitution. Reducing imports of major bulk commodities through improved performance of the respective domestic industries has been a major features of India's strategy to adjust to the external and domestic shocks on the balance of payments (Table 111.3). The greatest success on this front has been in the case of foodgrains in the 1970s and in the case of petroleum in the 1980s. In value terms, foodgrain imports were reduced from 24% of total imports in 1975/76 to less than 2% in 1978/79, while petroleum imports were reduced from 41% in 1980/81 to 21% in 1983/84. Crude oil output has expanded from 10.5 million tons in 1980/81 to 26 million tons in 1983/84; as a result, the share of imports in India's domestic consumption of petroleum and products has declined to 33%. -89- Table 111.3: INDIA: IMPORT SUBSTITUTION (Volume Indices) a/ 1973/74 1976/77 1980/81 1983/84 Petroleum 100.0 86.3 173.5 79.9 Foodgraina 100.0 127.3 13.7 86.0 Fertilizer 100.0 91.3 177.0 154.5 Iron & Steel 100.0 53.7 145.1 153.2 Non-ferrous Metals 100.0 60.7 256.5 152.6 a/ Converted from 1968/69 base. bP Based on physical quantities. Source: Ministry of Commerce, DGCIS; World Bank staff estimates for 1983/84. 9. The achievements of import substitution in the case of steel, fer- tilizer and non-ferrous metals are somewhat mixed (Table III.3). In the first adjustment period, there was a striking improvement in capacity utilization in the steel industry, and capacity utilization also improved in the case of nitrogen fertilizers. The combination of external and internal shocks in the 1979-81 period resulted in near stagnation and severe shortages of transport services and key inputs, leading to sharp deterioration in capacity utilization in steel, fertilizer, aluminum, etc. Again, significant improvements in performance have been recorded in the 1980s although individual circumstances and indicators have varied in each of these industries. These import substitution efforts have been assessed and dis- cussed in greater detail in Working Paper IV. 10. Import Liberalization. By the mid-1970s, as a result of the restric- tive import regime and the emphasis on import substitution in the past, the role of imports in the Indian industrial economy had been progressively narrowed so that imports of pronessed raw materials, manufactured inter- mediates and capital goods consisted only of items for which there was judged to be either insufficient demand to justify setting up in India, or for which technology or key raw materials were not available. Expansion of imports other than these "essential" imports threatened the production, either exist- ing or potential, of Indian manufacturing units. The first steps toward liberalization took place as early as 1976/77, but it was only after a more systematic overhaul of policy in 1978/79 that an effective compromise between these concerns emerged. The policy was most liberal with respect to inter- mediate inputs and raw materials not currently manufactured in India including, in theory, items not previously imported. Items which were manufactured in India but which had previously also been imported were sub- ject to licensing but licenses not only allowed automatically for growth over past import levels but could also be supplemented if production conditions -90- changed. The most restricted group of imports judged to be directly compet- ing with domestic production were available only to export units on the basis of a replenishment system geared to past export performance but unlike other import licenses these "replenishment" licenses could be freely transferred. The impact of this system on imports of industrial inputs has been very significant. Imports of non-bulk manufactures (raw materials and intermediates) increased by 15.6% per year between 1976/77 and 1983/84, when total import volume grew by 6.4% (Table III.4). 11. The "global tender" policy for capital goods, which was introduced in 1978/79, specified 13 industries (including most of the large capital inten- sive industries such as fertilizers, electric power, petroleum, petrochemicals, sugar, cement) which could call world-wide tenders for capi- tal goods, decided on the basis of c.i.f. import prices plus tariffs versus Indian bids irrespective of whether import bans, quotas or indigenization requirements would otherwise protect the Indian suppliers. This policy has resulted in an accelerated growth of capital goods imports in recent years. The improved access to modern equipment and technology, along with other measures to encourage foreign investment, have led to a rapid increase in foreign collaborations, from less ttan 300 agreements signed in 1979 to more than 700 in 1984. Table III.4: INDIA: IMPORTS OF CAPITAL GOODS AND OTHER MANUFACTURES ANNUAL VOLUME GROWTH RATES (%) a/ Capital Other Total Goods Manufactures b/ Imports 1973/74-1976/77 -1.1 5.3 -0.8 1976/77-1981/82 5.4 13.6 8.6 1981/82-1983/84 13.6 20.7 1.2 1976/77-1983/84 7.7 15.6 6.4 a/ End-point compound growth rates. Volumes derived by deflating the current price series using the unit value index of OECD manufactured exports (MUV). b/ Non-bulk manufactures, consisting mainly of industrial raw materials and intermediates. Source: Ministry of Commerce, DGCIS; World Bank staff estimates for 1983/84. 12. The rapid growth in imports of capital goods and other manufactures as a result of the liberalization measures indicate the extent of unfulfilled demand for such imports that had existed under the controlled import regime of the 1960s and early 1970s. The very high implied import elasticities -91- witnessed in recent years (between 1.5 and 3) are typical of a period of transition; they are not representative of the long-term levels at which these elasticities unay be expected to stabilize as India moves rmore fully to a more open trade environment. 13. As import liberalization has so far mainly affected those items which are not manufactured in India or for which adequate domestic capacity does not exist, the protective domestic environment and the associated high cost structure of Indian industry have not yet been significantly affected. While quantitative restrictions have been liberalized in many cases, the general level of import tariffs in India remains very high, limiting the impact of liberalization on the relative profitability of exports. Furthermore, the scope of the liberalization measures undertaken so far has also been limited by various qualifications pertaining to large firms (those covered by the MRTP and FERA regulations) and to industries reserved for the small-scale sector. C. Exports 14. Exports during the 1972/73-1978/79 period grew at an average rate of over 7% in volume terms, and increased in value terms from U3$2.6 billion to US$7.0 billion. Remarkable in this increase is that, with very few exceptions, the whole range of Indian exports experienced growth at some point over this time period. The value of some products would grow one year and if in the next year these products declined, growth in other products took place, more than compensating for falls in other areas, suggesting that general, rather than product specific factors, were behind this growth. Table 111.5 shows the growth rates for some of the more important exports. Particularly significant was growth in the non-traditional product areas of marine products, engineering goods, gems and jewelry and clothing. Value growth in these four product groups alone accounted for 43% of total value growth over the period. Export performance during and after the second oil shock has been very disappointing. After having achieved a 7% growth rate between 1972/73 and 1978/79, export growth has decelerated to 3.5% since then. This decentralization has occurred in spite of the fact that all the fast growing areas of exports in the 1970s continued to grow at over 7% annually, suggesting that again it is general factors, rather thaii specific loss on any particular front, that accounts for the slowdown. 15. Factors Influencing Export Performance. What are the genpral factors that have influenced Indian export performance in the past decade? One-of the most obvious factors is the stronger economic growth in the industrial countries before the second oil shock. Between 1972/73 and 1978/79, annual industrial country growth averaged 3.2%, and import volume for the same group of countries increased at 1.8% annually. Since 1979, growth in these countries has decelerated to 1.2%, while their imports have decreased by 2% in volume terms. -92- Table 111.5: INDIA: EXPORT GROWTH (values in US$ million) 1972/73 1978/79 1983/84 Value Volume Value Volume a/ Value Volume b7 Coffee 43 100 175 126 177 147 Tea 191 100 145 90 486 99 Marine Products 70 100 276 178 362 261 Oilcakes 97 100 134 189 215 209 Sugar 17 100 160 708 204 797 Iron Ore 143 100 284 107 415 129 Leather 239 100 432 74 355 45 Engineering 185 100 854 312 1,115 490 Gems & Jewelry 100 100 886 402 1,233 609 Clothing 72 100 532 433 693 668 Total 2,558 100 6,978 150 8,350 178 a/ Converted from the official. series with 1968/69 as the base. b/ Derived from physical quantities. Source: (1) Ministry of Commerce, DGCIS. (2) Export Promotion Councils (for 1983/84). 16. Other than the global demand conditions, a major factor that has influenced Indian export performance is the movement in the real effective exchange rate of the rupee and its impact on the relative profitability of exports vis-a-vis domestic sales. In the 1970s, the real effective exchange rate depreciated by an annual average of 3%. Over the first half of the decade, the slight depreciation in the real exchange rate resulted from a depreciating nominal rate which more than compensated for wholesale price increases which were far greater in India than abroad. During the second half of the decade, inflation in India grew at a slower pace than abroad. Combined with a nominal exchange rate which, in general, was continuing to depreciate, this caused the real exchange rate to continue to depreciate. In 1979, inflation in India again began to exceed that of its trading partners, and has continued to do so in every year except 1982. As a result, even with a nominal exchange rate which generally has continued to depreciate, the real exchange rate appreciated by about 10% between end-1978 and end-1980, and has shown little change since then. 17. The export incentive system has been the primary vehicle of the Government to promote export growth. Between 1973/74 and 1978/79, net export incentives (consisting of cash compensatory support, customs duty drawbacks, premia on replenishment licenses less export taxes) were increased from 2.6% to 6.5% of total exports, which further enhanced the profitability of -93- exports. Since 1979, net incentives have grown more slowly, reaching 7.9% of total exports in 1983/84, which has not been significant enough to offset the effect of the real appreciation of the rupee. 18. Statistical tests were run with data for the years 1970/71 to 1983/84, to test the historical relationship between the real effective exchange rate and export performance. Also included as independent variabLes in the calculation were an index of industrial country CDP growth and an index of Indian CDP growth (as a proxy for availability of exportables). rhe regression run confirms the positive relationship between Indian export volume growth and the real effective exchange rate. 1/ While Lhe world's economic growth, as represented by industrial country growth, has a strong effect on growth in Indian exports, so has the renl effective exchange rate. 19. As there is a significant correlation between Indian and global economic growth, to avoid the problem of multicollinearity, separate regres- sions were rur. using thesc two variables one at a time, along with the real exchange rate variable. Indian GDP growth does have a significant effect on exports when the global economic growth variable is dropped from the equation, but its effcCL is not as strong as the impact of the real exchange rate, whose coefficient increases to 1.1. In all the regression runs the elasticity of the volume of Indian exports with respect to the real effective exchange rate is at least 0.3. 1/ log X = 0.0029 + 0.80 log REER + 1.12 log WY + 0.24 log IY (R = 0.975) (4.48) (4.12) (0.14) where X = Indian export volume REER = Real exchange rate (in terms of rupees/foreign currency) WY = Industrial country GDP growth IY = Indian GDP growth. DW = 2.18 SEE = 0.038 Figures in parentheses are the t-values. -94- WORKING PAPER IV AGRICULTURE, FOOD, AND POVERTY Prepared by Leslie Abbie and Roger W. Grawe -95- WORKING PAPER IV ACRICULTURE, FOOD, AND POVERTY Page No. A. Three Decades of Agricultural Progress.......*................ 96 Production Performance ................................ ...... 96 Policy Framework.......................................... 99 B. Food and Poverty.............................................. 100 Dimensions and Characteristics of Poverty..................... 100 Poverty-oriented Policies..................................... 102 C. Economic Performance and the Poor.................C........... 104 D. Foodgrain Performance and Prospects........................... 106 Variability of Foodgrain Production........................... 107 Foodgrain Availability....................................... 110 Foodgrain Prices, Agricultural Wages and Consumption of the Poor..................................... 112 E. Lessons of Recent Experience for Policies Towards the Poor.... 117 F. Socio-Economic Dimensions of Poverty.......................... 120 Nutrition...................... .............................. 121 Fertility..................................................... 126 Health........................................................ 127 Education ..................................................... 128 Tables IV.1 Agricultural Production Growth Rates.......e.......... 98 IV.2 Public Social Expenditures, 1984/75- 982/83................ 105 IV.3 Public Foodgrain Procurement and Dist=ibution System........ 110 IV.4 Prices of Food and Other Commodities, 1970/71-198/848....... 113 IV.5 Average Real Wage Rates for Male Field Labor in 14 Selected Districts, 1966/67-1980/81................. 114 IV.6 Consumption Profile of the Rural Poor....................... 115 IV.7 Simulated Effects of Policies on Major Economic Indicators.. 119 IV.8 Progress in MCH Programs, 1975/76-1983/84...... 126 Figures IV.1 Foodgrain Production, 1967/68-1984/85....................... 108 IV.2 Per Capita Foodgrain Production and Capability, 1967/68-1983/84....... ........................ 109 -96- WORKING PAPER IV 1/ AGRICULTURE, FOOD, AND POVERTY A. Three Decades of Agricultural Progress 1. Production Performance. Agriculture still dominates the Indian economy, in spite of its low trend growth since Independence (2.4% per annum in value added). In 1983/84, it accounted for almost 35% of GDP and over 65% of employment. Given India's low income level and the unremitting pressure of poverty on nearly half of India's 750 million people, the management of the foodgrain economy is critical to the effort to reduce the impact of poverty on basic welfare. The links between foodgrain consumption (the basic source of nutrition for the poor), health status and literacy indicate other dimensions of the poverty nexus which have also received emphasis in the Government anti-poverty strategy but which have as yet failed to match the progress made in food security. In addition to a direct impact on poverty the generation of agricultural incomes also plays a critical role in the interaction of supply and demand in India's macro-economy, and in that con- text also in the balance of payments. Agro-based industry accounts for about one-third of industrial output, and non-durable consumer goods which rely heavily on rural demand still account for well over a quarter of industrial production. Direct inputs to agriculture, primarily fertilizers, are also an increasingly significant industrial subsector, making increasing claims on public resources and, often, on foreign exchange. Finally agriculture and related infrastruccure constitutes an important source of demand for engineering and other basic industries which have been at the core of India's industrial strategy. 2. While a major focus of Chapter 2 is India's adjustment to external shocks during the 1973-83 decade, domestic shocks, primarily weather induced fluctuations in agricultural output, were certainly more significant in their impact on GDP and in shaping Indian economic policy. It was a notable characteristics of the 1970s in India that both oil price shocks coincided with periods of serious agricultural setbacks. The period 1972-74, spanned two poor and one mediocre harvest which gave rise to widespread and sericus concern that the Green Revolution had exhausted its potential, while in 1979 India experienced one of the most severe droughts in recent history: agricultural production fell by more than 15% to a level less than 5% greater than in 1970/71, nine years earlier. 3. Thus in both the post-1973 and post-1979 periods adjustment to exter- nal shocks had necessarily to be complemented by agricultural recovery. The relative success in both periods can be gauged from the trough to peak agricultural production growth of 6.2% per annum between 1974/75 and 1978/79 1/ This Working Paper, together with six others, supports the analysis in Chapter 2 of the Report, India: Structural Change and Development Perspectives, Report No. 5593-IN, dated April 24, 1985. -97- and 7.4% per annum between 1979/80 and 1983/84. If this strong production response had not been forthcoming, India would not have sustained the long- term agricultural trend growth rate and the already slow process of struc- tural transformation would have been set back. It is one of the ironies of India's stage and structure of development that without more rapid agricul- tural growth India will have great difficulty sustaining the very processes which will ultimately lessen the vulnerability of the economy to agricultural fluctuations. The remainder of this section will describe briefly (1) some key structural characteristics of both agricultural output and input growth during the two adjustment periods; (2) changes in the policy framework, and (3) the public investment strategy and priorities for the future. 4. Foodgrains domination of agricultural production has steadily increased since Independence although in the 1973-83 decade the differential between foodgrain and non-foodgrain growth narrowed somewhat (Table IV.1). Over a 33-year period only fruits and vegetables and sugarcane output increased more rapidly than foodgrains; this was true in the most recent decade as well. Both these non-foodgrain crops plus wheat (and spices) 1/ grew more rapidly in the 1973-83 decade relative to their 30-year trends. In both recovery periods during the recent decade, wheat lead the way; but in the second period, the differential between wheat and rice virtually disap- peared as the growth of wheat decelerated slightly while the performance of rice improved. Overall the performance of foodgrains and non-foodgrains improved in line with the aggregate acceleration of agricultural production during the second period. Within foodgrains wheat production grew more rapidly in the earlier period, but responded impressively after both shocks. Rice production averaged better in the second period but this was primarily due to a stronger immediate spurt in the initial recovery year rather than a steady acceleration of growth. While groundnut and sugarcane production was significantly better between 1979/80 and 1983/84, production of other non- foodgrains particularly cotton, plantation crops, spices, fruits and vegetables grew much faster in the 1974/75-1978179 period. 5. Three summary points emerge from this review: first, wheat continues to register rapid growth reflecting the continuing impact of the green revolution strategy; second, the stepwise growth in rice production indicates a broadening base of improved inputs and practices during the monsoon season, particularly in drought recovery years; finally the relative setback in several non-foodgrain categories in the second period appears to have par- ticularly affected India's agricultural export base, thus further exacerbat- ing the relatively weak export performance during the second external adjust- ment period. 1/ Growth in spices production accelerated significantly in the 1973-78 period and then declined between 1978-83 to a rate well below the long- term trend. -98- 6. Input use in agriculture has risen markedly during the 1973-83 decade. Total utilized irrigated area which had increased by only 10 million hectares between 1964/65 and 1974/75, doubled its growth during the next five years so that by 1979/80 another 10 million hectares had been added. During the 1979/80-1983/84 period this pace has been maintained or perhaps slightly accelerated. Over the entire 1974-83 decade this acceleration in irrigation was shared by both groundwater development (55%) and surface (major and medium at 35% and minor at 10%). By 1983/84 total irrigated area as a proportion of ultimate potential had reached 54% as compared to 37% a decade earlier. Table IV.1: AGRICULTURAL PRODUCTION GROWTH RATES Triennium 1950/51- ending 1974/75- 1979/8G- 1983/84 1973/74-1983/84 1978/79 1983/84 Agricultural Production 3.0 3.0 6 2 7.4 Foodgrains 3.2 3.0 7.5 8.7 Wheat 5.9 6.6 10.2 9.1 Rice 3.1 3.0 7.9 9.0 Non-foodgrains 2.6 2.8 3.5 4.7 Oilseeds 2.3 2.3 1.6 6.6 Fibers 2.2 1.5 2.0 -3.1 Plantation Crops 2.8 2.5 3.4 0.4 Spices 1.6 3.1 6.3 1.3 Frvits & Vegetables 4.5 5.3 6.9 5.8 Sugarcane 3.8 4.6 5.6 16.6 Source: GGI, Ministry of Agriculture, "Production of Principal Crops" mimeo. 7. Duriag this decade the growth in gross area planted under high yield- ing varieties has also increased markedly from 65% of gross irrigated area in 1974/75 to 86% in 1983/84. Almost 50% of the increase in HYV area occurred in rice cultivation, about 30% in wheat (the remainder in millet, sorghum and maize). Between 1980/81 and 1983/84, Punjab, Haryana and U.P. still accounted for 17.1% of the increment in area under HYV cultivation. Nevertheless this was far lower than the share of these States in the growth of earlier years, and lower than the growth of many States which had pre- viously lagged behind in HYV adoption. Bihar accounted for the largest share of HYV growth at 13.8% followed by Maharashtra, M.P., A.P. and Rajasthan. Taken together these five States accounted for well over half the total growth in HYV cultivation during 1980-84. The strong growth of HYV in the 1980s over a wider range of States has been an important factor in the strong production response after the 1979/80 drought. -99- 8. The remaining key input is fertilizer, the consumption of which grew by 10.6% per annum during the decade 1973/74-1983/84. Growth during this period was far from smooth, however. During the three years 1975/76-1978/79 consumption spurted at 20.9% per annum having stagnated between 1973/74 and 1975/76. Growth between 1978/79 and 1982/83 was quite modest at 5.6% per annum before another spurt of almost 22% in 1983/84. Between 1978/79 and 1983/84 only three States accounted for over 50% of the increase in fer- tilizer consumption: U.P., Punjab, and Andhra Pradesh. In 1983/84 these States plus Tamil Nadu accounted for over 53% of all fertilizer consumed in India relative to their share of 37% of gross cropped area. While there has been some reduction in the skewness of fertilizer use, it would seem that less progress has been made in broadening the base of fertilizer than in irrigation of HYV. The scope for continued substantial increases in fer- tilizer consumption is further illustrated by a comparison of Statewise per hectzre consumption in 1983/84 with similar figures for 1975/76. At 149.3 kg/ha Punjab recorded levels not only considerably above the all-India average of 44.9 kg/ha but well beyond Tamil Nadu at 86.7, Andhra Pradesh and U.P. (69.2 and 68.3 respectively), the next most intensive users of fertilizer. In 1975/76 fertilizer use in Punjab amounted to only 47.2 kg/ha followed much more closely by Tamil Nadu at 39.5 and Andhra Pradesh (25.4). Already in 1975/76 in Punjab over three-quarters of cropped area was fertil- ized (almost 2-1/2 times the all-India average) so that the tremendous growth of subsequent years in Punjab reflected primarily increased application of nutrients on already fertilized land. 9. Policy Framework. The strong production response of agriculture following the two domestic shocks of 1972/74 and 1979/80 and the associated increase in input availability occurred in the context of an evolving set of policies, institutions and investments in agriculture. The food crisis that India faced in 1972/74 during which public stocks of foodgrains dropped as low as four months' offtake through the public distribution system, and procurement fell short of issues by almost 11 million tons, called into question the basic approach to agriculture that India had followed from the beginning of the green revolution in the late 1960s. Fertilizer consumption was stagnating even before the massive price increases which occurred in 1974 following the oil price shock. The impact of the threefold price increase in imported fertilizer was reduced to a 90Z increase in the domestic retail price (these percentages relate to urea, price changes for other products were similar) by virtue of lower domestic costs of production and the application of import subsidies. Procurement prices for paddy and wheat increased 51% and 38% respectively between 1972 and 1974 while wholesale price inczeases reported in major markets ranged from 45% to 106% for rice and 64% to 111% for wheat. Foodgrain imports which were less than half a million tons in 1972/73 grew to 3.6 and 4.9 million tons in each of the following years but even these amounts were inadequate to relieve the pres- sure on the system. As a result direct controls on foodgrain sales and movement were imposed or strengthened. Foodgrain zones which had been a feature of Indian agriculture since the 1960s were reinforced through the short-lived banning of wholesale trade in the kharif marketing season of 1973 -100- and other measures intended to increase procurement in surplus areas and discourage speculation and hoarding. Direct controls were also introduced in the distribution of fertilizers which, in spite of stepped up imports, were in short supply in 1973/74. 10. By 1974/75 it was apparent that the direct controls were not paying off either in terms of input supply or output procurement. Even before intimations of the favorable crop of 1975/76, plans were made to improve the supply position of both foodgrains and fertilizers through significant increases in imports in the 1974-76 period (43% per annum and 23% per annum respectively). Willingness to import even as the balance of payments deteriorated severely due to the oil price shock is a mark of the relative importance attached to domestic versus external adjustment by policy makers- an importance quite justified given the fundamental role of agriculture in the economy and the importance of food availability to the poo-. In addition the assurance of foreign exchange resources through increased concessional assistance undoubtedly facilitated a willingness to import in time and in adequate amounts. The functions of wholesale traders in foodgrains were restored in the 1975 procurement seasons. Retail fertilizer prices were lowered (8% for urea, 15% for phosphate) to counteract the staguant demand which had emerged in 1974. Sizeable imports were maintained in 1976; consequently, input supply improved markedly, facilitated by the removal of direct controls on distribution. As a result, fertilizer consumption got back on a high growth track increasing by 18% in 1976/77 (probably helping to minimize the decline in production that year following a very mediocre monsoon). Continued food imports during 1976/77 were the key factors in India's ability to set up a foodgrain buffer stock that would allow for considerable expansion in the public distribution systew. Daring the period between 1976 and the next severe shock following the drought of 1979, remain- ing direct controls on the foodgrain economy were eliminated, notably the zonal system which had restricted the inter-regional movement of foodgrains. During this period procurement pricing policy reflected a judicious mix reflecting a balance of productinn cost considerations with consumer and public distribution needs. The resilience of this policy framework which relies primarily on indirect incentives in the domestic market and the active use of imports in anticipation of domestic requirements is underscored by its stability since the late 1970s. During these years India has dealt with two severe droughts without resort to distress imports of foodgrains while dis- tributing substantially larger amounts of grains through the public distribu- tion system for sustained periods. B. Food and Poverty 11. Dimensions and Characteristics of Poverty. The links between food availability and poverty in India are manifold. Perhaps the strongest reate to the very definition of poverty in terms of the expenditure level associated with the consumption of basic calorie norms. By this criterion roughly half India's population were classified as poor at the end of the 1970s, a proportion that had resisted any marked secular decline during the -101- previous two decades while exhibiting significant annual fluctuations, mir- roring those in agriculture. The consumption basket of the poor is dominated by foodgrains so that trends in the availability of foodgrains and in their cost are significant determinants of the incidence of poverty. Average consumption of the poor was Rs 53 per month (in 1979/80 prices), but this average conceals wide variations in the intensity of poverty. The incomes of those near the poverty line 1/ may, in normal circumstances, enable basic calorie requirements to be met even at the cost of dietary boredom. At the other extreme, the poorest 10% of India's population are probably at serious risk of malnutrition. For all the poor, access to non-food basic needs, such as health care, education, shelter and clothing is at best barely within grasp. Evidence about recent poverty trends is not conclusive. In the last 20 years, income distribution appears to have shifted, if only very gradually, in favor of the poorest 40% of the population, 2/ while the dis- tribution of Landholdings may have stabilized in more recent years. 3/ Expenditure survey data on the pioportion of those below the poverty line during the last decade are available for only one year in the past decade, 1977/78. Thus it is not possible to bring direct evidence to bear on recent poverty trends. Based on estimated relationships between agricultural growth and poverty incidence, indications are that the proportion of those living in poverty in recent years may have declined somewhat following the product acceleration in agricultural growth in recent years and the efforts of recent yez%a to enhance anti-poverty programs. 41 But fluctuations remain and it seems unlikely that there will have been significant declines. At any rate, as population continues to grow at over 22%, the absolute number of those in poverty increases by several million people each year. 1/ At the start of the Sixth Plan (1979/80 prices), the poverty line was defined as monthly per capita expenditure ot Rs 76 in rural areas and Rs 88 in urban areas. These are the mid-points of the monthly per capita expenditure classes, which consume 2,400 calories per day in rural areas and 2,100 calories per day in urban areas. 2/ Sources are Recent Trends in the Distribution of Personal income by I.R.K. Sharma, mimeo, January 1981; Sixth Five Year Plan, Technical Note. See 1984 Economic Report, Vol. II Main Repcrt, pp. 129-130 (Report No. 4962-IN), World Bank. 3/ See All India Reports on Agriculturzl Census, 1970/71 and 1976/77. 4/ "Rural Poverty in India: 1956/67 to 1973/74", by M.S. Ahluwalia in India: Occasional Papers, World Bank Staff Working Paper No. 279, pp. 2-41 and also "Rural Poverty, Agricultural Production and Prices: A Re-examination," 1983, unpublished draft manuscript by M.S. Ahluwalia, for the forthcoming Agricultural Change and Rural Poverty, International Food Policy Research Institute, Washington, D.C. (IFPRI). -102- 12. Eighty percent of poor people live in rural areas and 78% of the rural poor work directly in agriculture. Of these, nearly 50% have either no land or less than a quarter acre. The bulk of the rural poor therefore depend either partly or wholly for their livelihood on wage employment in agriculture or allied activities. Apart from this link to production, there is also a link to consumption in that the poor spend their money mainly on food and concentrate their food expenditure on foodgrains, which account for 53Z of India's agricultural output. Thus, the importance of agriculture for the poor has two facets. Also, even with expanding irrigation, Indian agriculture remains highly dependent on rainfall. Yearly fluctuations in agricultural production due to unpredictable weather, combined with the normal seasonalities of agricultural operations cause considerable uncer- tainty and instability in both the incomes of the poor and the prices of the commodities they consume. While discovering no Long term trend in poverty, M.S. Ahluwalia's work 1/ demonstrated substantially annual and periodic instability in the head count measure of poverty which closely followed variations in agricultural production. These links imply that agricultural growth can be a powerful tool for poverty reduction in India--a mechanism which has been demonstrated empirically in several studies. 2/ This has implications for the design of development policy and the allocation of public resources which are examined below. 13. Poverty-Oriented Policies. The problems of framing an appropriate Government poLicy towards agriculture and the poor in rural areas has been a key issue in India for many years: "The Sultan gave orders that all ... viLlages ... should pay tribute in kind. Corn was brought into the granaries ... of Delhi. When there was a deficiency of rain ... and grain became scarce in the markets, then the royal stores were opened and the corn was sold at the tariff price, Leording to the wants of the people. Through these ... rules, grain never was deficient in the markets, and never one dang above the fixed price." 31 14. Programs and policies to raise the incomes of the poor through the process of growth are the main long-term weapon in the Government's anti- poverty strat'gy. The rural nature of poverty and the importance of food in the budget of the poor mean that the public investment program to raise agricultural productivity is especially critical. Expenditures on 1/ Ibid. 2/ See 1984 Economic Report, op. cit., pp. 131-135. 3/ Description of public food distribution system operated by Sultan Ala-ud-din Khalji (A.D. 1296-1316) from A History of Agriculture in India, Vol. II by M.S. Randhava. -103- irrigation, research, extension and input supply facilities help raise and stabilize yields for small as well as large farmers and increase employment opportunities for laborers. Incentive pricing policies for agzicultural inputs and outputs and large scale investments in power and fertilizer production have also been important supportive elements in India's agricul- tural effort over the years. However these programs take time to implement and to yield results, since not only resources but also difficult institu- tional changes are often needed to improve growth. Hence, there is also a crucial role for anti-povertl measures which attempt to alleviate poverty directly or cushion the poor against the worst effects of natural disaster or food scarcity. Such measures have a long tradition in India. Countless examples of beneficient intervention precede Ala-ud-din's scheme and are reported with increasing frequency afterwards through the periods of Moghul and British rule. The importance of food distribution, tax relief and public works as measures of famine relief has long been recognized in India. In the last century, the dual role of public works both as a source of employment for drought-stricken farmers and laborers and as a form of insurance against future disaster was increasingly stressed with the construction of the first major "protective" surface irrigation systems. Over time, and particularly since Independence, the connotation of irrigation systems as a form of famine relief has largely disappeared, with increasing emphasis on the production benefits of irrigation. Given its long gestation, irrigation investment could never replace traditional short-term measures to relieve the effects of natural disaster, and these latter have continued. Also, other forms of investment such as food distribution facilities (roads warehouses, etc.) have taken place to improve the management of short-term crises, particularly following the lessons of the great Bengal famine in 1943. All these measures have enabled millions of Indians either to escape or to service better the effects of natural disaster. Yet millions remain poor, and vulnerable to the consequences of a sudden and unforeseen loss of income. This feature of life in India remains as importance for economic management today as it has over many centuries. 15. The brief historical review above suggests that a basic commitment to preserve consumption standards for the poor has long been and continues as a minimum objective of public policy. This is justified by the extremely low consumption levels still experienced by almost 50% of the population, and the instability of the natural environment in which most of the poor must operate. The instruments and programs in place to achieve this objective are now larger and more complex than even 10-15 years ago. Table IV.2 shows public expenditures on programs such as calamity relief and food subsidies which give short-term consumption assistance to the poor. Since 1974/75, these expenditures have risen at about 8% per annum in real terms. This is mainly due the expansion of the Public Distribution System (PDS) in which public stocks of foodgrains (rice and wheat) and other commodities are dis- tributed at subsidized prices to ration cardholders through an extensive system of "fair price" shops. Tax (land revenue) and loan repayment relief are two other traditional short-term measures by Government to assist the poor in rural areas. While the importance of land revenue relief has -104- declined with the erosion of the tax base, deferred loan repayments for drought relief have become a major instrument of State Government policy. These explain a significant, if imprecisely known, proportion of the poor credit resources in agriculture. 16. Public resources are also used to assist both the rural and urban poor directly by helping to overcome the most important concomitants of poverty--lack of income-earning opportunities and assets, poor health, illiteracy and large family size. The National Rural Employment Program (NREP) aims at creating durable assets and employment in lean periods. 1/ The Integrated Rural Developmeit: Program (IRDP) encourages asset ownersRip bnd self-employment through a ctmbination of subsidy and credit. Both NREP and IRDP continue various programs established through the 1970s and Table IV.2 shows their increasing importance. Finally, human development programs for health, education, social welfare and family planning have been growing rapidly in real terms since 1974/75. 2/ The benefits of these programs are evident in the declining rates of infant mortality and fertility, and increasing life expectancy and literacy recorded between the most recent population censuses. Howe these benefits have been distributed is not known, though it is probable that the poor who comprise 50% of the population have not benefited in the same proportion. In summary, Table IV.2 shows that public expenditure on consumption, poverty alleviation and human development programs rose steadily as a proportion of total public expendi- tures between 1974/75 and 1983/84 with a particular spurt in tne first three years of the period. C. Economic Performance and the Poor 17. India's economic strategy vis-a-vis the poor since the early 1970s has been to cushion their living standards against short-term disruptive shocks, while attempting to remove povert7 through a combination of general economic growth and specific social and anti-poverty program. There are no data which track directly the incomes of the poor over the last 15 years. Regrettably, the most recent information on the level and pattern of consumption across expenditure groups is for 1973/74 and 1977/78 only (see Table IV.3). This paucity of information is partly due to the fact that the frequency of expenditure surveys has, since the early seventies, been greatly reduced to make room for the collection of other data. Since any specific expenditure survey can be substantially influenced by e.g. the weather in that particular year, present statistical practice makes it 1/ A similar role is performed by State sponsored programs like Maharashtra's Employment Guarantee Scheme. 2/ Expenditures on these programs are only very rough indicators of assis- tance to the poor. In particular, the importance of expenditure on higher education in the total education budget should be noted. -3.05- Table IV.2: PUBLIC SOCIAL EXPENDITURES, 1974/75-1982/83 (millions of rupees in constant 1970/71 prices) a/ Social Expenditures Social Poverty Human Total Expenditurea Consumption AlLeviation Development Public as % of Total Programs b/ Programs c/ Programs d/ Total Expenditures el Public Expen4 1974/75 2,565 111 12,432 15,109 77,586 19.5 1975/76 2,449 37 18,719 21,206 98,483 21.5 1976/77 3,573 166 19,971 23,709 103,468 22.9 1977/78 3,640 390 21,531 25,561 109,468 23.3 1978/79 4,128 1,473 24,292 29,E93 124,283 24.1 1979/80 4,458 1,087 24,110 29,654 125,932 23.7 1980/81 4,419 1,664 26,793 32,876 137,939 23.8 1981/82 4,199 2,339 28,632 35,170 144,584 24.3 1932/83 4,684 2,116 32,603 ;9,403 158,730 24.8 a/ All expenditures are deflated by the GDP Deflator derived from National Accounts Statistics. b/ Consumption programs comprise Relief on Account of Natural Calamities, Food Subsidy, Edible Oil Subsidy and Controlled Cloth Subsidy. c/ Data for 1973/75-1979/80 comprise a mix of poverty oriented programs such as Small Farmers Development Agency, Scheme for Marginal Farmers and Landless Laborers, Food for Work. Programs for 1980/81 onwards are IRDP and NREP. d/ Social programs comprise Social Security and Welfare, Education, Health, Family Welfare, and Labor and Employment expenditures. e/ Total public expenditures are developmental and non-developmental expenditures on both revenue (recurrent) and capital accounts. virtually impossible to track general trends in poverty over recent years. For other reasons, the benefits to the poor of investment in social services and in anti-poverty programs can also not easily be identified. The implementation problems of IRDP and NREP were discussed in last year's Economic Report. 1/ but it is not yet possible to gauge their overall effec- tiveness in reaching down to the poor. After five years of operation, fur ther investigations of their impact are needed. Given the size and urgency of the poverty prcblem, and the volume of public resources used directly and indirectly to help the poor, these are all serious gaps in India's data base. 1/ See 1984 Economic Report, op.cit., pp. 135-140. -106- Improved statistics on poverty and on the impact of public expenditures would be highly beneficial, enabling policymakers to channel resources more effec- tively to help the maximum numbers of the poor. Despite these gaps, knowledge of the occupations and sources of income of the poor, and of their consumption preferences, does permit some assessment, albeit imperfect, of how the poor have fared. In the following paragraphs, trends and variability in agricultural production and incomes, availability and prices of com- modities consumed by the poor, and wage rates in the agricultural sector are examined. 'While these indicators do not give a complete picture of poverty, they are indicative, and support conclusions reached elsewhere 1/ that the head-count of poverty has probably not declined over the long-term. However within the period analyzed (1970/71-1983/84), there have been significant short-term variations around the long-term poverty trend. As expected, the main source of instability for the poor over this period wag the weather and its effect on crop production. The impact of internal shocks on the poor was mitigated in a limited but effective way by public food policy including, when necessary, access to imported food. Public expenditures on agriculture, human development and anti-poverty programs also grew rapidly despite the external shocks suffered by India during the 1970s. Taken together, these trends suggest that the poor were largely insulated from the effects of these external shocks. D. Foodgrain Performance and Prospects 18. Successive droughts in 1971/72, 1972/73 and 1973/74 caused severe economic problems for India. As agricultural production declined, farm incomes and employment suffered, and food prices began rising rapidly. Public foodgrain stocks declined rapidly from 8.1 million tons in December 1971 to 3.1 miltion tons at the time of the first oil shock in late 1973-barely adequate to sustain four months of public cereal rations. The second half of the decade was very different. Foodgrain production resumed an acceptable growth path, culminating in a record harvest of 132 million tons in 1978/79, and food prices were remarkably stable. The second oil shock in 1979 coincided with anott2r severe drought, cutting foodgrain output by 17%. However public stocks had been built up since the mid-1970s, first by sizeable imports and later by increasing domestic procurement. As a result, pressures on food availability and price inflation, though still strong, proved more manageable. In !982/83, after another severe drought, foodgrain production fell, though not precipitousy, and prices rose more rapidly than before. But long term agricultural output growth of 2.4% has been maintained, public foodgrain stocks and distribution expanded with only moderate imports, and foodgrain output in 1983/84 and 1984/85 has exceeded expectations, Progress in gross and per capita foodgrain production and availability since the late 1960s is charted on Figures IV.1 and IV.2. 1/ See Ahluwalia, op.cit. -107- 19. Foodgrains account for 68% of agricultural production and absorb around 60% of the consumption of the poor. Consequently, aggregate trends and.fluctuations in foodgrain production are closely associated with the living standards of the poor. This relationship is less valid at the more micro level, given the different experiences of individual States, and socio- economic groupings. Yet the macro trends are indicative. Between 1967/68 and 1983/84, foodgrain production has growr. at a trend rate of 2.5% per annum This amounts to a modest but positive trend growth of 0.25% per annum in per capita terms. Identifying shorter time trends within this overall picture is difficult since estimates are very sensitive to the choice of end-points. Nevertheless, Figure IV.1 shows a perceptible steepening of the growth path after 1974/75. This observation should not be interpreted as demonstrating an improvement in the Long term growth rate of foodgrains production. A higher trend growth of 3.4% per annum between 1978/79 and 1983/64--the last two record harvests--and the quite modest production shortfall in the severe 1982/83 drought are indeed hopeful indicators. However it is too early to reach such strong conclusions. Rather, the distinction between pre- and post-1974/75 is worth drawing because it points to & definite turning point both in India's food security generally and in the fortunes of the bulk of the poor after the traumas of the early 1970s. Though growing somewhat more slowly than per capita physical foodgrain output over the same period, per capita agricultural income trends mirror these results. 20. Variability of Foodgrain Production. Through a combination of good weather, an effective public investment program and an expanded input and output price support system for foodgrains, Indian agriculture has progressed significantly over the last 10 years. Yet per capita production and income trends have been at best modest, due to rapid population growth. Moreover, Figures IV.1 and IV.2 illustrate the continuing year-to-year instability of agriculture. The impact of drought on per capita production is pronounced (Figure IV.2), and even provides some evidence of increasingly wide fluctuations. Per capita production has peaked successively in 1970/71, 1975/76, 1978/79 and 1983/84, but had touched progressively lower troughs in 1972/73, 1974/75 and 1979/80. It is in this context that the relatively modest decline in per capita availability in 1982/83 was so welcome. Similarly encouraging is the achievement of record foodgrain output in 1984/85 under less than optimum weather conditions, unlike previous peak years, The evidence therefore suggests that although the poor both as producers and consumers of foodgrain remain quite vulnerable to the income and price effects of 2luctuating foodgrains production, there may recently have been some impro-ement. Nevertheless, the data graphed here probably underestimate the effects of the fluctuations on the poor, given the average nature of the data and the weakness of the poor when faced when severe income fluctuations. FNgure-IV.1 INDIA Foodgraln ProductIon, 1967/68 - 1984/85 Millions (mIllions of tonnes) ofTons 150 140 130 - 120 100 1967/68 68/69 69/70 70/71 71/72 72/73 73/74 74/75 75/76 76/77 77/78 78/79 79/80 80/81 81/82 82/83 83/84 84/85 Fiscal Years Wodd Bank-27360 � � "7 � вввьввввьввввьввввввввв.ввв■вв■вввьвьвв Ф ввву.вввrв.• � ьв,•ь � . � � в � • � �_ в 1% ■....■..в.вввьввььвввввввь � _ ввввв■ввввьввв■ввiffвв.. � а � ~� овввrпвв а . /'1 ввл ьУввввввввв■ввоr■ а n С � _ �_ i вввввввввви ..�ввввввввввввв�в v �'v ••'.. N о м � ьв.,в�' � О� D �i � •вва n о н g �� � i{ � Q � I •�1�вь } вввrвыrвввивввве• „ г .� ,цj � вввr■■вwв■ввв й 'ц. .в1��вввввввввввввивьввввввввв■ ^ Yi � � (ду �О (� вввввввwвлвв■вь �Q и ьвь� �iOy ь�вв��ь � � •вввв�вввввrгвв'в'•в ^ � у: •�}�вв • в. :С ььвв•вьв�ввь ^ а •в�•• � ввввввввввввввввввввrввввьввьввв �` �. ;� ,�1 Уьв•вв••вввввввввв г � t�j ввввr � +�. Q вьв � ; •rвввьвььвввььвь ,О ■ •вь i ьв+ь . �•� • � 1 1 1 .в�_ в�( •ввв• 1 � h.рΡ � � v� � � � V R V � � �� _110- 21. Foodgrain Availabili!iX. Besides foodgrain production, changes in private and public foodgrain stocks and foodgrain imports affect the total availability of foodgrains. Though their size and movements over time are unknown, private foodgrain stocks are important and have undoubtedly been used to dampen the effects of fluctuations in foodgrain production to some extent since the early 1970s. However, it is apparent that the Government's role as a regulator of foodgrain availability has also been vital. Figure IV.2 shows that per capita foodgrain production fell on three occa- sions (1972/73, 1974/75 and 1979/80) to levels which in the absence of public intervention would probably have caused consumption also to fall unacceptably far, even by India's meagre average consumption standards. The nature and extent of this intervention has changed over this period. Domestic procure- ment operations, storage facilities and the public distribution system (PDS) have all grown substantially. This reflects partly the rising demands of a growing population and partly the increased importance of domestic, relative to imported, foodgrains as a source of supply. Table IVA: PUBLIC FOODGRAIN PROCUREKENT AND DISTRIBUTION SYSTEM OEerations (millions of tons) Number of Domestic Public closing Ration Shops Procurement Imports Distributicz Stocks (thousands) 1970 6.7 3.6 8.8 5.3 122.0 1975 9.6 7.4 11.3 8.0 240.2 1982 15.4 2.1 14.8 12.8 283.0 Source: Bulletin of Food Statistics, Ministry of Agriculture (various years). The trends shown in Table IV.3 are also reflected in the growing food subsidy, which measures the difference between the procurement prices paid to farmers and the issue prices of the ration systems plus storage and distribu- tion charges. Public foodgrain operations have had multiple objectives which include not only the supply of cheap grains to the poor, but also guaranteed remunerative producer prices and the maintenance of an "adequate" national grain buffer stock. The need to contain the fiscal burden of the food sub- sidy So LhaL other development Programs are not squeezed implies a difficult trade-off for the Govert ent--between the positive effect of higher producer prices on food production and hence availability for the poor, and the short- term benefits of subsidized food for lower income groups. Producer price incentives also have to be seen in the context of large and growing fer- tilizer subsidies, which are seen by the Government as an important stimulant to agricultural growth by helping to hold down imput costs for farmers. In practice, both producers and consumers have had to accept limits on the scope of operations because of these constraints. On the distribution side, the -111- gap between ration and free market prices has not been allowed to widen over time, while ration sales are still mainly confined to the major urban centers, despite the expansion of fair price shops noted above. 1/ 22. In its use of foreign exchange for food policy, the Government has been concerned to ensure at all costs a minimum level of foodgrain availability at times of domestic scarcity through increased imports. The events of 1973-1976 following the first oil shock and consequent balance of payments disruption demonstrate the strength of this commitment. The failure of domestic foodgrain production due to drought in the early 1970s saw foodgrain (mainly wheat) imports rise from 4-6Z to 18% of a rapidly increas- ing import bill for India between 1973 and 1976, peaking at 7.4 million tons in 1975. However except at times of acute shortage, the Government has generally pursued a conservative policy towards the use of food imports to achieve short-term impro7ements in food availability. With domestic produc- don recovering from 1975 onwards, foodgrain imports have now declined to negligible levels on average. Yet per capita foodgrain availability has continued to fluctuate markedly from year to year. Equally important, availability has shown virtually no positive trend increase in the long term, although there has recovery from the low point of the early 1970s. The opportunity-and cushion--provided by declining food imports has been used partly to increase edible oil imports significantly in recent years. However the decline in foodgrain imports also reflects a belief, on the part of policymakers, in the need to concentrate public resources on programs and policies which can reduce poverty in the long term, rather than merely alleviate it in the short term. Thus, key elements in the public investment programs such as irrigation, fertilizer production and power generation, which support agricultural growth directly or indirectly, have also been insulated to the extent possible, from India's external shocks and stepped up whenever extra resources have become available. The large jumps in the fertilizer subsidy in the mid and late 1970s also reflected a desire to protect farmers' incentives from the price effects on chemical fertilizers of the two oil shocks, and thus restore the growth momentum. In effect, this strategy acknowledges that the resource needs of a public food policy which could insulate all or many more of the poor from the effects of variable food production and availability would be huge, and that the benefits foregone by cutting back other development programs to finance those needs would be even larger. Still, despite their limited role (in relation to the size of the poverty problem), the influence of public foodgrain operations should not be underestimated. Though only a small proportion of production, domestic procurement typically absorbs around 50% of market arrivals, while wheat rations account for between 60-80% of market arrivals. Thus, prices are significntiy affected by public intervention. Also the willingness of the 1/ Data on ration sales through urban versus rural outlets are not available. It is certainly likely that relatively more grain is allo- cated to rural shops in drought areas. -112- Government to hold increasingly large grain stocks has probably led to the release of more private stocks for consumption over time-a trend not cap- tured in the availability statistics. While not measurable, the influence of public operations on private behavior is therefore considerable. 23. Foodgrain Prices, Agricultural Wages and Consumption of the Poor. Trends in the prices of commodities consumed and wages earned by the poor support the notion that the real incomes of the poor have fluctuated con- siderably over the last fifteen years. These trends are shown in Tables IV.4 and IV.5. In the first half of the 1970s, foodgrain prices rose rapidly in nominal tems, and relative to the prices of all other commodities. In contrast, between 1974/75 and 1979/80, prices were remarkably stable in India and the relative price of foodgrains declined significently. After 1979/80, inflationary pressures re-emerged, though foodgrain prices have not risen more quickly than other commodity prices. Though unavailable for the most recent years and widely varying both within and between States, real wages of agriculcural laborers appear also to have followed different trends over distinct periods--first falling substantially in the first half of the 1970s, then rising markedly from the mid-1970s onwards. 24. It is difficult to infer long-term trends in the consumption of the poor farm data as aggregative and unstable as those on the availability and prices of foodgrains and on agricultural wages. Over the shorter term, it is evident that th2 recovery of agricultural production from 1975/76 onwards boosted employment and real incomes in the rural sector compared with the early 1970s. At the same time, foodgrain availability also improved, helped initially by higher imports. How these changes affected consumption patterns in rural areas is shown in Table IV.6. 25. The NSS data confirm the importance of food and foodgrains in the budget of the poor, compared with those in relatively higher income brackets. Since 1973/74 and 1977/78 were, respectively years, of poor and excellent agricultural production, these data enable the consumption responses of the poor tc be examined when real incomes change significantly. In 1977/78, physical quzatities of foodgrains purchased by the poor (not shown in Table IV.6) increased significantly over 1973/174 levels, particularly by those in the poorest decile. However, the proportion of expenditure committed to foodgrains declined for all groups, including the poorest. For higher income groups, additional demand for foodgrains in 1977/78 was weak, even negative in some cases. Thus, the decline in relative foodgrain prices over this period appears to have resulted from the interaction of much improved availability with relatively weak additional demand in aggregate, reflecting the inelasticity of demand for foodgrains as incomes rise. However these aggregates disguise both relatively strong additional demand for foodgrains by the poor and, over this period, substitution by the poor of superior cereals (rice and wheat) for coarse grains (sorghum, maize, etc.) within their total foodgrain budget. Table I.4: PRIVEF OF OOD AND OTMER COMMODITIES, 1970/71-1983/84 Index Numbers Averaie Annual Percentage Change 1970/71 L974/75 L1979/ 19831/84 1970/71-1974/75 1974175-I19180 1979/80-1983/84 1. Food Articles IU 172.1 186.6 282.9 14.5 1.6 11.0 Foodgrains a/ 1Ou 195.8 185.4 273.1 18.3 -1.1 10.2 Other Foon Articles b/ IOU 154.0 186.9 288.3 11.4 4.0 11.4 2. Food Products c/ 1OU 186.9 214.8 299.U 16.9 2.8 8.6 Edible Oile IOU 172.4 193.4 303.5 14.6 2.3 11.9 3. All food (excluding toodgrains 1OU 168.5 199.2 293.1 13.9 3.4 10.1 4. Wholesale Price Index (excluding foodgrains) 100 171.? 222.0 32U.8 14.5 5.3 9.6 Memo Items a. Price of Foodgrains Relative to Prices ot All Other Food 1OU 116.0 93.1 93.2 3.8 -4.3 0.0 b. Price at Foodarains Relative to Price of all Other Commodities. OU 114.0 84.0 85.1 3.3 -5.9 0.3 .i/ Foodgrains include cereals (rice, wheat, coarse grains) and pulses. bj Other food articles are fruits and vegetables; milk and milk products; eggs, tish and meet; condiments and spices; and beverages and tobacco. E/ Food prooucts are dairy products; canned and preserved truits and vegetables; canned ana preserved tish ano sea tood; grain mill products; bakery products; sugar, khanOsari and gur; sugar contectionary; cocoa and chocolate; and edible oils, oil cakes and miscellaneous products. Source: Index numbers at Wholesale Prices, Ministry ot Industry. -114- Table IV.5: AVERAGE REAL WAGE RATES FOR MALE FIELD LABOR IN 14 SELECTED DISTRICTS, 1966/67 - 1980/81 al 1966/ 1967/ 1970/ 1971/ 1974/ 1978/ 1979/ 1980/ 67 68 71 72 75 79 80 81 Andhra Pradesh Malgonda 1.38 1.24 1.46 1.30 1.13 2.23 2.43 1.98 West Codovari 1.45 1.59 1.87 1.61 1.42 1.77 1.83 1.86 Bihar Monghyr 0.92 1.00 0.97 n/a 1.39 1.33 1.29 1.29 Saran 1.27 1.40 1.17 n/a 1.75 1.58 1.89 1.89 Gujarat Kheda 1.25 1.56 1.71 1.51 1.25 1.92 1.71 1.54 Mebsana 1.31 1.41 1.46 1.55 1.06 1.95 1.80 1.69 Madhya-Pradesh Bilaspur 0.84 0.68 0.91 0.96 0.72 1.19 0.94 1.15 Surguja 1.09 1.37 0.78 0.72 0.64 1.04 0.91 0.87 Punjab Gullunder 1.84 2.34 3.09 3.41 1.83 2.53 2.67 2.75 Gurdaspur 2.18 1.66 2.84 2.63 1.83 2.08 1.87 1.80 Tamil Nadu Gojmbatore 1.09 1.16 1.44 1.54 1.11 1.53 1.38 2.30 South Arcot 1.77 2.03 1.63 1.60 1.22 1.68 1.90 1.09 Uttar Pradesh Faizabad 0.59 0.76 1.37 1.30 1.31 1.20 1.20 1.20 Meerut 1.18 1.17 1.91 1.82 1.63 2.01 1.73 1.53 a/ Annual average nominal daily wage rates deflated by the Consumers' Price Index for Agricultural Laborers. Sources: 1. Agricultural Wages in India (various years), Ministry of Agriculture. 2. Bureau of Labor. -115- Table IV.6: CONSUMPTION PROFILE OF THE RURAL POOR (percentages) 1973/74 1977/78 Distribution Below Below of Consumption Poorest Poverty Total Poorest Poverty Total Expenditure Decile Line Population Decile Line Population FOOD 83.3 82.5 74.9 79.1 76.9 64.3 Foodgrains 64.0 59.4 48.3 58.3 52.3 37.4 Milk & Products 1.7 4.0 7.2 1.9 4.3 7.7 Edible Oil 3.3 3.8 3.8 3.4 3.9 3.6 Vegetables 4.2 4.2 3.8 4.6 4.6 3.8 Spices 2.4 3.0 2.5 3.9 3.6 2.8 Other al 7.7 8.1 9.3 7.0 8.2 9.0 NON-FOOD 16.7 17.5 25.1 20.9 23.1 35.7 Tobacco 3.2 3.0 2.9 3.5 3.3 2.9 Fuel & Light 7.8 6.6 5.6 9.4 7.8 6.0 Clothing 1.6 2.7 6.8 2.2 4.0 8.7 Other b/ 4.1 5.2 9.8 5.8 8.0 18.1 ALL ITEMS (100.0) (100.0) (100.0) (100.0) (100.0) (100.0) a, Meat, fish, egg, fruits and nuts, sugar, salt, beverages and refreshments. b/ Footwear, durable goods, miscellaneous goods and services, rents and taxes. Source: Surveys of Consumer Expenditure, 1973/74 and 1977/78, National Sample Survey. Limited demand for coarse cereals explains the relatively easy price trends displayed by coarse cereals after 1975/76, despite declining per capita availability. Moving into the early 1980s, these favorable trends reversed themselves to some extent. In the drought years 1979/80 and 1982/83, agricultural incomes declined. But foodgrain demand fell less than availability, leading to renewed price pressures on foodgrains, which were partly alleviated by higher stock releases replenished in the following year by wheat imports and higher procurement. For the poor, these years probably saw some reversal of their gains in the second half of the 1970s. However, foodgrain price pressures were less severe than in the early 1970s and extremely good foodgrain production in 1983/84 and 1984/85 have probably corrected this reversal. 26. Table IV.6 also shows that, as incomes rise, the poor spend small but increasing proportions of income on other food items such as edible oils, milk, fish and eggs. For all the population, demand pressures on these foods rise significantly. At the same time, increased availability of these goods -116- (partly engineered by public policy) accommodated the growing demand. Significantly higher edible oil imports were permitted by the Government, and domestic eggs and milk production increased markedly, while sugar supplies, though very cyclical, were also on average higher since exports were cur- tailed below the substantial levels achieved in the early 1970s. Thus, as in the case of foodgrains, the role of foreign trade as a regulator of domes- tic availability was critical-either to raise imports in the case of edible oils or to restrict exports in the case of sugar. Continued demand growth and price pressure on these income elastic food items as average incomes rise further will have an increasingly important effect on consumption standards of all the poor, who even now depend on these items for dietary variety. The higher inflation of these items since 1979/80 (Table IV.4) therefore suggests some slippage in the consumption standards of the poor relative to the latter half of the 1970s. 27. Viewed from the long term perspective, the agricultural experience of the last decade and a half provides no conclusive evidence that the proportion of those in poverty is declining over time. Though fluctuating considerably in the short term, per capita income growth in agriculture has risen at best modestly on a long term trend, while per capita foodgrain availability has been virtually static. Also, real agricultural wages do not appear to have rise in the last two decades. Within this framework, there are however several hopeful indicators. Foodgrain production has grown more quickly than population to the point where availability has been maintained in recent years with virtually no recourse to imports. The response to the 1982/83 drought showed much greater resilience and the recovery in 1983/84 and further production increase in 1984185 reconfirmed the potential for continued growth. These trends have improved domestic food security, while saving foreign exchange. Partly compensating for reduced foodgrain imports, edible oil imports have been significantly stepped up, thus improving the combined foodgrain-edible oil balance in the last decade. The Government's ability to accumulate larger foodgrain stocks primarily from domestic sources has also increased confidence that public authorities can alleviate the worst effects of short term food scarcity-speculative hoarding, price inflation, etc.-both reliably and without excessive delay. Finally, foodgrain price trends over the last decade have been appropriate to India's agricultural and socio-economic objectives. Available evidence suggests that relative foodgrain prices have not softened due to any decline in effective demand of the poor. Rather, it appears that, as average per capita incomes rose, very weak demand in the upper income groups may have "released" more foodgrains for consumption by the poor, in favor of processed and higher quality foods. In turn, the poor seem to have substituted higher for lower quality grains, as the relative availabilities of both changed over time. More analysis of the changes which are occurring in India's foodgrain demand structure are needed before these trends can be conclusively accepted. Furthermore, the demands of the poor for additional calories through foodgrain consumption remain large, even if current levels of availability can better accommodate their existing demands. To meet these additional demands, further progress -117- on foodgrains production and mechanisms to direct available foodgrains more effectively towards the most needy are required. E. Lessons of Recent Experience for Policies Towards the Poor 28. Poverty in India is a huge and pervasive problem, with deep-rooted and complex causes. The evidence of the recent past does point to the fact that when agriculture has done well, the bulk of the poor have done well, and vice versa. Over the longer term, agriculture has been performing satisfactorily, both historically and by international standards. Yet rapid population growth has largely offset these gains, resulting in very modest per capita income growth in rural areas. These aggregates also conceal wide regional divergences. In some some States, particularly those in eastern India, sluggish agricultural performance and higher than average population growth have undoubtedly made life more difficult and uncertain for the poor in recent years. In other States, like Punjab and Haryana, agricultural growth appears to have acted as an effective weapon against poverty, reducing its incidence far below the national average. For the future, recent experience shows that merely sustaining the long-term agricultural growth rate will not reduce the proportion of the population in poverty, let alone the absolute numbers of the poor. India's development strategy must there- fore allocate public resources in ways which can help raise agricultural growth, particularly in those regions which have been lagging. However it is also entirely appropriate that, as in the past, India should continue to use other programs and policies to alleviate poverty. The difficult issue for policymakers is how to reconcile competing claims by all of these programs on scarce resources. In last year's economic report, the important roles played by human development programs for health, education, family planning and nutrition were discussed. The need to focus expenditure on primary education, basic village level health care, and on nutrition interventions specially targeted to groups most at risk was emphasized. For the major national anti-poverty programs IRDP and NREP, the benefits of more effective targetting and better quality control were stressed rather than accelerating the pace of expenditures. In the following paragraphs, some trade-offs between the use of public resources to alleviate poverty through (a) short-term interventions to raise consumption of the poor, and (b) long-term investments and incentive policies to raise growth are examined. 29. In Table IV.7, the impact of different uses of public res6urces are simulated using a general equilibrium model of the Indian agricultural sector. 1/ Using econometrically estimated measures of supply and demand 1/ See "Income Distribution in India: The Impact of Policies and Growth in the Agricultural Sector" by Jaime B. Quizon and Hans P. Binswanger. Discussion Paper Report No. ARU21, Research Unit, Agriculture and Rural Development Department, Operational Policy Staff World Bank. -118- responses in India, the model allows the production, price and income dis- tribution effects of particular policy options to be traced. The model takes account of complicated feedback effects with occur when, for example, a rise in foodgrain production causes prices to fall, thereby hurting producers while helping consumers. Since many of the poor are both producers and consumers of food, this feature of the model is particularly opposite to an analysis of the impact of policies on the poor. Some economy-wide effects and implications of policy change in the agricultural sector are not captured in the model and so results should be interpreted cautiously. 1/ However as indications of the direction and broad magnitude of the effects of different policy options, the results of the model are instructive. 30. Assuming a given volume of public resources to be available, Table IV.6 presents the impact of four policy options: (a) import more wheat, releasing it on the open market to increase food availability; (b) raise the food subsidy; (c) increase irrigation investment; (d) increase the fertilizer subsidy; and (e) increase irrigation investment while reducing the fertilizer subsidy by an equivalent amount. Policies (a) and (b) illustrate ways to raise food consumption of the poor immediately; (c) and (d) are options to help the poor by raising agricultural productivity; (e) then considers the trade-off between investments in irrigation versus increases in the fertilizer subsidy. Raising imports achieves its objectives of increasing per capita cereal consumption and helps the poor by forcing foodgrain prices down. However there are disincentive effects for farmers who cut back production somewhat, thus reducing the net benefit of increased imports on food availability. Raising the food subsidy (without any increase in food availability) has opposite effects. As ration card holders the urban poor do benefit. However increased demand for food pushes up its price on the open market, thus hurting those outside the ration system (mainly the rural poor) but stimulating farmers to raise agricultural production, if only moderately. Options (c) and Cd) demonstrate the positive impact of both the fertilizer subsidy and, in particular, of irrigation investment on agricultural production, and hence on domestic food availability. This in turn leads to lower food prices, which benefit the poor considerably while also reducing farm profits. Thus the income distribution effects of agricultural growth compare very favorably with the outcomes achieved under short-term consumption policies explicitly directed at the poor. The simulation also suggests that the net benefits of more irrigation at the expense of lower 11 For example, the response of producers of non-agricultural commodities to changes in the incomes of all consumers and in the prices of agricul- tural commodities is not captured in the model. Nor are the foreign exchange implications of decisions concerning trade in agricultural commodities taken into account. -119- Table IV.7: SIMULATED EFFECTS OF POLICIES ON MAJOR ECONOMIC INDICATORS a/ (percentage change) b/ Import Raise Increase Increase Increase Irri- More Food Irriga- Fertilizer gation/Reduce Wheat c/ Subsidy tion d/ Subsidy Fertilizer Subsidy Agricultural Production -0.06 0.07 0.76 0.28 0.48 CNP Deflator (Prices) -2.31 1.00 -2.90 -0.23 -2.67 Real Income of: Poorest Rural Quartile 0.60 -0.24 0.98 -0.07 1.04 Richest Rural Quartile -1.36 0.78 -1.84 0.49 -2.33 Poorest Urban Quartile 2.16 1.14 2.73 0.13 2.60 Richest Urban Quartile 1.03 -0.02 1.61 0.08 1.53 Per Capita Cereal Consumption 0.62 0.08 0.055 0.03 0.52 al Each scenario uses resources equivalent to 50% of India's average fertilizer subsidy between 1979/80 and 1981/82 (Rs 2.4 billion). This does not imply any reduction of fertilizer subsidy, except in last column. b/ Percentage change measures the change in any economic indicator due to the policy change, relative to the actual outcome in 1980/81. c/ Equivalent to 1.4 million tons of wheat at 1980/81 world prices. d/ Full recovery of D&M costs of irrigation assumed. Benefits of irrigation discounted over 50 years at 12% per annum to ensure comparatibility with other policy alternatives. Since irrigation benefits flow immediately after investment in the scenario, these results are analogous to those which arise from investment in groundwater wells, rather than surface irrigation where gestation lags are longer. Source: 1. Quizon and Binsuanger, op. cit. 2. "A Note on Simulation Results from a Model of the Indian Agricultural Sector" by Jaime B. Quizon, unpublished paper. -120- fertilizer subsidies would be substantial. Cutting the fertilizer subsidy would have disincentive effects for farmers, but these would be outweighed by the beneficial effects of irrigation investment noted above. 1/ 31. The results of the simulations above are supportive of the general thrust of India's development strategy for the poor in recent years. This thrust recognizes that the poverty problem is so large and pervasive in Irdia that programs to promote growth, and particularly agricultural growth, offer the best hope to alleviate poverty. Well implemented programs to raise growth are also a prerequisite for the effective operation of essential short-term poverty relief measures, since they generate the food and resour- ces necessary to support these measures. Conversely, had policies been adopted which emphasized at the margin the short-term welfare of the por, thrcugh, for example, a vastly expanded food distribution system and/or a significantly higher level of food imports, at the expense of policies to promote agricultural growth, it is likely that in the longrun the results would have been counterproductive both for the poor and the economy as a whole. As is appropriate, India's strategy has indeed been to allocate substantial resources to help the poor improve their productivity. As options are considered for the future, the issue of how poverty and its symptoms can best be tackled directly needs to be addressed. In particular whether public resources are better directed towards mitigating the short- term effects of income fluctuations on the poor by expanding public foodgrain operations further, or whether outlays to provide assets to the poor like IRDP should continue to be stepped up, are questions which deserve to be examined more closely irn the future. Also, given the recent sharp rise in the level of public foodgrain stocks after two good years of production and the associated costs of holding high stocks, examination of alternative strategies for the disposal of grain appears timely. Wheat exports may offer a temporary solution. However in the event that stocks remain high over time, programs to release foodgrains for the benefit of the poor on a larger scale, and the costs of such options relative to other anti-poverty programs, need to be assessed. F. Socio-Economic Dimensions of Poverty 32. Indian scholars have devoted considerable attention to studying the characteristics of the poor in different parts of the country and among difference groups of the society. The most potent data sources on the sub- 1/ Since irrigation benefits accrue over an extended period of time, the comparison between investment in irrigation and expenditures on programs which yield immediate consumption is dependent on the choice of discount rate, i.e., the rate at which society discounts future as agairst present consumption. The result that irrigation benefits outweigh the benefits of other options is howfver only moderately sensitive to alternative assump- tions about the discount rate which are significantly higher than 12X. -121- ject are the recent National Sample Surveys whicb have gathered information on the pattern of consumptinn expenditure and the level and pattern of employment during 1972/73, 1977/78 and 1983. Un."ortu-ately, these data are not yet to be analy.ed intensively. In the meanwhile, the most comprehensive analysis cf the correlates of poverty is based on the State samples of the NSS conducted in Gujarat and 4shnrashtra States of India during 1972/73. It indicates poverty to be correlated with a higher than average size of households, a significantly above average proportion of children less than 15 years of age, higher level of illiteracy, lower school enrollment ratios amoaS children aged 5 to 19, a higher level of participation in economic activity by women, a higher level of open unemployment (measured in terms of person days), greater instability of employment (a higher proportion of casual workers), and a low proportion of white collar workers. I/ 33. Apart from these statistical correlates, a large body of literature has developed on the interrelations between poverty, nutrition, health, mortality and fertility, family size, education, productivity, etc., and the intergenerational trnsmission of poverty through a number of these factors. These relationships are extremely interwoven and complex, and are sometimes referred to as the "seamless web" of socio-economic conditions within which poverty prevails and persists. It is outside thc scope of this report to review these relationships in any comprehensive manner. Many of these are still hypotheses or, if given great importance by some, are questioned by others. In addition to the question of causality, there is the further and related question through which factors policy interventions can best mitigate the extent and impact of poverty. Some of the interrelations in the seamles: web have been discussed in the 1984 Report. Here the focus is primarily on (a) the effects of malnutrition among infants, children, mothers and adults and the efforts to ameiiorate them and to a lesser extent (b) the effects of higher literacy and education among girls and women. ThiL choice is sug- gested by clear indications among States of willingness to allot fairly sizable resources to supplementary feeding for children and for pregnant and lactating mothers. Also, the Central Government has chocen a rapid promotion of literacy and education among females as a key policy goal and it has close links with fertility, survival and health of children. 34. Nutrition. Between the two, the nutritional dimension will receive greater attention because of the pervasive effect of malnutrition among infants and children on their survival, productivity throughout their lifetime and the inter-generational transfer of perpetuation of poverty. The importance of inadequate food intake associated with poverty and Leading to malnutrition among both adults and children has received particular attention in recent years. Malnutrition is associated with low labor productivity. 2/ 1/ Pravin Visaria, "Poverty and Living Standards in Asia "Population and Development Review, Vol. 6, No. 2 June 1980 2/ N. Rao Maturu, "Nutrition and Labor Productivity", International Labor Review, Vol. 118, No. 1, January-February 1979. -122- The productivity of anemic workers in Indonesia, who were given iron supple- ments for two months, was found to have increased 15-25%, depending on the type of work performed. Similar results have been obtained in Kenya where the provision of extra iron to Lower anemia and treatment of hookworm were found both inexpensive and feasible. 1/ Malnutrition and anemia among preg- nant women are important causes of low birth-weights of their babies, which is a key determinant of their chances of survival. Relatively inexpensive food and iron supplements to womea in the last trimester of pregnancy are known to increase the birthweights of babies and lower infant mortality. 35. The data gathered by the National Nutrition Monitoring Bureaus in several States indicate nearly 17% of the school children to be suffering from severe malnutrition associated with a weight deficit (for age) of mcre than 40%. 2! A fairly large sample study of the National Institute of Nutrition, Hyderabad, has reportedly found nearly 63% of the children below three years of age and 40% of children between three and five years of age to be suffering from anemia; the problem was moderate or severe in 10%. 31 Body weight of less than 60% of the "normal" is reported to be "invariably associated with definite evidence of functional incompetence". Iron deficiency also has deleterious effect on the brain biochemistry and function and thereby on human behavior and cognition itself. Studies conducted by the National Institute of Nutrition have shown clear indications of positive association between the order of pregnancy and (a) anemia--both mild and severe--as well as (b) signs of nutritional deficiency among pregnant women. The prevalence of nutritional deficiency among preschool children has also been found associated with parity or order of birth. Alsc, some hospital studies have shown positive association between family size and the incidence pf morbidity and mortality due to nutritional disorders. These associations have been noticed within the same socio-economic group. The analysts have attributed it to the duration of lactation and the quality of child care which may also reflect the iiteracy and educational status of the parents. 4/ The synergism between low famiLy size, literacy or education, better nutrition, lower infant and child mortality can be mutually reinforcing. I/ The World Bank, Population Health and Nutrition Department, Nutrition Review, Washington, D.C., April 1984. 21 C. Copalan, Nutrition and Health Care: Problems and Policies (a) com- pilation of Recent Addresses), New Delhi, Nutrition Foundation of India, 1984, pp. 13-14. 3/ Ibid, p. 26. 4/ S.C. Srikantia and Yogananda Sastry, Proceedings of the First Asian Congress of Nutrition, edited by P.C. Tuipule and K.S.J. Rao, 1971, pp. 584-91. Cited by N. Prahlad Rao, "Daterminants of Nutritional Status in India", in: Hans P. Binswanger, et. al., Rural Household Studies in Asia, Singapore: Singapore University Press, 1980, pp. 162-166. -123- 36. Malnutrition and associated morbidity and mortality are partly seasonal. Besides the studies in Bangladesh and Gambia reporting seasonal variations in malnutrition and associated morbidity and mortality, a study in Coonor, South India, has shown a marked peak in the incidence of severe protein-caloric malnutrition (Kwashiorkor) among children during May and June, following a peak in infective diarrhoeas during April and May (the "fly season" in the region). 1/ As seasonal increase in the proportion of mal- nourished children has been reported at the end of the dry season, when the ioad availability is at its lowest, in four tribal villages of Gujarat. 2/ The seasonal peaks and troughs reflect the fluctuations in the cycle of economic activity and the availability of water, which are difficult to eliminate. The seasonally important public works programs and the food distribution network are expected to help mitigate the magnitude of malnutri- tion and its effects on certain infectious diseases. 37. Over the past 35 years institutionalized feeding programs in various forms have been initiated to mount a direct attack on the problem of mal- nutrition and poverty. Prior to Independence, the subsidized or free dis- tribution of food grains was often resorted to mitigate the impact of severe droughts which were frequent in different parts of the subcontinent. In 1950, the FAO, the UNICEF, other international organizations and the GOT had begun a program of supplementary feeding for children, pregnant women and nursing mothers. Later in 1956, Tamil Nadu has introduced a mid-day meals scheme for school children throughout the State. The program was modified to include nutrition education and called the Applied Nutrition Program. It began under that label in Orissa and Andhra Pradesh in 1960, in Uttar Pradesh in 1962 and in other States during 1963. Other projects of different sizes and with varying emphasis have been tried in different States; several of them have also been evaluated A common theme of the evaluations has been that the net increase in the caloric intake has been less than the value of the supplementary food, the take-home food is shared with other members of the family, while that provided at the feeding centre did not always reach the target children because they could not come to the centres by themselves. Nutrition education, expected to be the most effective, has not really made much headway. 1/ The study was conducted during 1950-53. See: Venkatachalam, P.S. et. al, "Clinical Features of Nutritions Oedema Syndrome in Children", Indian Journal of Medical Research, Vol. 42, No. 4, pp. 555-67 cited in: N. Prahlad Rao, "Determinants of Futritional Status in India", in: Hans P. Binswanger et. al, Rural Household Studies in India, Singapore; Singapore University Press, 1980, p. 152. 2/ ARCH, Action Research in Community Health, Mangrol, "The Report of Activities for the period April 1982 to March 1983", mimeographed. -124- 38. A World Bank assisted project, focused on nutritional surveillance, diarrhoea management, deworming, immunizations and vitamin, mineral and food supplementation, has been implemented in about 9000 villages in six of Tamil Nadu's 14 districts during 1980-85. The monthly village-level weight monitoring of growth by a community nutrition worker determines whether a child in the age group of 6-12 months has gained less than 300 gms per month and one in the 12-35 months age group has gained less than 100 gs per month in the previous three months. If the very low weight gain persists, the child is given supplementary food, 40 grams (140 calories) for children under two years of age and 80 grams (280 calories) for children aged 2-3 years, until it is restored to an acceptable pattern of weight gain (500 gms of weight gain over three months of feeding). The severely malnourished children, estimated at 10% of beneficiaries, receive double rations. For pregnant women, the daily supplement is 80 grams for the last trimester of pregnancy and the first four months of lactation. This project has had significant effects on lowering the proportion of children needing supplemen- tary feeding, has led to a decline in the incidence of severe and moderate malnutrition in the project area (while it has increased in the control area), and has probably averted at least 12,000 deaths.11 Nutrition educa- tion and communications activities have also been found to be quite success- ful largely through the use of voluntary women's groups as village contact points. 39. A leading Indian Nutritionist has criticised the Tamil Nadu Nutrition Project for its "elaborate, expensive, time-consuming and complicated selec- tion procedure". According to him the "saving" on food supplements "claimed to be the merit of selection" will be more than offset by "the wastage of precious time and resources" spent in the selection process. Nany needy children are likely to be excluded from the food supplement because of the insistence on low weight gain for two or three months as its condition. 2/ The criticism results from some lack of information. All severely mal- nourished children are enrolled at once in the program. Other children enter the program after failing to gain adequate weight over two months in the case of children aged 6-12 months and three months in the case of children between 1-3 years. These criteria were designed to minimize the effect of errors of measurement or chance factors; and after the initial period, only two obser- vations are considered adequate to admit the moderately undernourished children into the feeding program. Further, children gaining 500 grams over a 90 day food supplementation are discharged while those failing to gain by that amount are referred to the nearest PHC for identification of health disorders. The critics emphasize that 25 percent of the benefitting children 1/ World Bank, Population Health and Nutrition Department, Nutrition Review, April 1984. 2/ C. Gopalan, "Choosing 'Beneficiaries' for Feeding Programs", NFI Bulletin, Vol. 5, No. 4, October 1984. -125- relapse into undernutrition; but the 75 percent who do not relapse form the vast majority of the beneficiaries. Those who relapse constitute barely 5% of the total population whose nutritional status is monitored. 40. Meanwhile, the Government of Tamil Nadu has or. July 1, 1982 extended the mid-day meal scheme to all children aged 2 to 15 years who come to several thousand child welfare centres and elementary schools where food is cooked. Recently, on November 19, 1984, Gujarat has launched a mid-day meal scheme for its 5 million children in 30,000 schools covering 18,000 villages. It is likely that other States will follow the example. The employment opportunities created for women to work as cooks and run the program are an important attraction of these schemes. In addition, they are said to help increase the enrollments and attendance in schools. The Planning Commission has reported the gains in school enrollments to be small relative to the investments (Sixth Five Year Plan, p. 378). However, Tamil Nadu has made enrollment in schools a condition for access to feeding centres. While enrollment does not necessarily mean attendance, school enrollments have certainly shot up after the feeding program has begun.1/ Perhaps, the scheme can help to mitigate the effect of extensive discrimination against girls, but without careful monitoring and evaluation these effects are unlikely to be assessed or documented. 41. Young children below age two are left out of the Tamil Nadu midday meals program and all children of preschool age are left out of the Gujarat Scheme. They are to be covered by the centrally-sponsored Intens5ve Child Development Service (ICDS) Program, which program aims to improve the nutri- tional and health status of children up to six years of age, to provide antenatal and postnatal care in the form of immunization against tetanus and supplementary nutrition to expectant and/or nursing mothers and to provide them proper nutrition and health education. The IDCS Scheme is expected to cover 1,000 blocks by the end of the Sixth Plan. Under the schemes food supplements are given to children and the expectant and nursing mothers (at the preschool centres or Anganwadis on 300 days -er year). The severely malnourished children (assumed to be 20% of the total) are given an addi- tional supple=nt for 45 to 6C days. 42. The program is said to be successful in improving the health and nutrition status of children. The original plans envisaged feeding of only the malnourished children and the quantum of food supplement was to be related to the degree of malnourishment. In actual practice, all the children attending the welfare centres are given the food supplement irrespective of their "grade" or level of undernutrition. It is claimed that many children with only mild malnutrition do not turn up regularly at the centres, so demand for food supplements does not exceed the available 1/ P.K. Balachandran, "A square Meal - and Schooling - for Every Child", UNICEF News, 1984, No. 1, p. 9. -126- resources. The impact of ICDS on child nutritional status has not been systematically evaluated. 43. India's maternal and child health (MCH) program has emphasized nutri- tional supplementation among both pregnant and lactating mothers rnd among young children as well as the immunization of children against diphtheria, pertusis, tetanus, polio and now measles. The table below sumarizes the progress on each of these programs. Table IV.8: PROGRESS IN MCH PROGRAMS, 1975/76-1983/84 Beneficiaries (million) during Item 1975/76 1980/81 1983/84 1. Tetanus Immunization of Expectant Women 1.45 5.28 7.45 2. Immunization of Preschool Children 2.41 1.15 10.16 3. Nutritional Supplements (a) Mothers 3.70 6.24 15.48 (b) Children 3.52 9.56 14.19 4. Prophylaxis against Vitamin A Deficiency 4.48 16.64 15.48 44. These statistics do not necessarily imply that the programs meet the targets or expectations in terms of the potency of the vaccines, or the regularity and adequacy of the nutritional supplements. But they do attest to the seriousness of intent at various levels of Government. If Indias is to cover 50 percent of its 130 million children below 6 years of age (in 1985) with a supplementary nutrition program like Tamil Nadu or Gujarat, the cost would range between Rs 10 and 20 billion, depending on the State whose norm is accepted. (The apparently low cost of the food supplement under the ICDS is presumably due to its overhead and ancillary expenses being covered under the health budgets). While the welfare considerations might probably justify such a large expenditure and even larger sums are currently spend on food and fertilizer subsidies, the requisite organizational effort poses the more serious challenge. 45. Fertility. High infant mortality is linked with high fertility. Insofar as couples decide on the level of fertility allowing for some mor- tality loss, a decline in the level of infant and child mortality would, at least with a time lag, lead to a decline in the desired number of children. While the threshold level of infant and child mortality has not been clearly identified, lower infant mortality lengthens the interval between births through the protection against pregnancy provided by continued breastfeeding. It also reduces the need to "replace" children who have died and strengthens -127- the parents' concern for raising the "quality" of children in terms of schooling, education and even nutrition. 1/ 46. Despite a sharp decline relative to the 1940s, infant mortality in India remains high (114 in 180) by current international standards, The inter-State variation is considerable, ranging between a low of 42 in Kerala and 168 in Uttar Pradesh. Kerala is reputed to have achieved its low IMR and a life expectancy of around 65 years, not because of a higher level of economic development, but largely because of very high level of literacy (86% and 71% among men and women aged 15 and over in 1981), with relatively small rural-urban or sex differentials. The per capita State domestic product in Kerala during 1980-82 was only about 1,400, 15% below the national average (and eighth among the 15 major States). Malnutrition is said to be rampant in Kerala and the facilities for safe delivery with a trained birth attendant are probably the critical factor in its low INK. 47. The Working Group on population policy that reported to the Indian Planning Commission in 1980 and proposed the now accepted goal of attaining a net reproduction rate of one by 2001 A.D. had emphasized that the social development programs of adult and elementary education, and the extension of primary health care, nutrition and protected water supply and sanitation in rural areas will help to create motivation for smaller families by lowering infant mortality and raising the physical quality for life. These considera- tions also supported the "minimum needs program" that was incorporated in the Sixth Five Year Plan 1980-85 with a total planned outlay of Rs 15.5 billion for rural health, elementary education and nutrition. 48. Health. Nationally, about 81 to 10% of the infant deaths in India during 1978 were reported to be caused by dysentery diarrhea. 2/ In 1979, almost 32% and 38% of the deaths in the age group 1-4 were caused by digest- ive disorders and gastroenteritis (the corresponding figures for all registered deaths were 10% and 34%, respectively). A large majority of these deaths due to diarrhea and gastroenteritis are considered preventable with the simple and inexpensive oral rehydration therapy (ORT) which India now tries to promote as a component of primary health care. 49. An important cause of infant mortality is neonatal tetanus which can be prevented relatively easily if the pregnant women are immunized against it. Likewise, malnutrition is partly a result of extensive parasitic infec- tion of the intestines among both children and adults. Deworming is, therefore, an important part of the program of promoting nutrition. 1/ Rodolfo A. Bulatao, "Reducing Fertility in Developing Countries: A Review of Determinants and Policy Levers," World Bank Staff Working Paper, No. 680, pp. 17-18. 21 Office of the Registrar, Survey of Infant and Child Mortality, 1979. -128- Likewise, widespread Vitamin 'A' deficiency is said to be responsible for both nightblindness and possible eventual blindness. 50. Severe malnutrition among babies and young infants is recognized as a key factor retarding the growth of brain and leading to a permanent handicap throughout the rest of life. Malnutrition affects the duration and severity of infectious illness. The incidence and the period of contagiousness of infection itself is increased by malnutrition. 1/ The recurrent, severe and prolonged episodes of diarrhea, experienced by malnourished children, retard the physical growth and development because of reduction of food intake caused by the loss of appetite by the child and the withholding of food by the mother or both and also the inadequate absorption of whatever food is consumed. Overall, malnutrition contributes to low intelligence, poor educability, inadequate cognitive development (aggravated es well by the burden of work and inhospitable family environment), an overrepresentation of the poor among those who never go to school or who dropout from schools. 51. Poverty and malnutrition also lead to a high incidence of absenteeism from work due to greater morbidity among workers as well as children who need to be looked after. Such loss of time has not been quantified; but given an association between poverty and morbidity as well as mortality, the poor certainly bear a disproportionately high burden of it. Lower infant and child mortality would enable the poor to devote some of the unproductively used time to income yielding economic activities. 52. Education. Several studies have confirmed an inverse association between literacy or education of mothers and the level of infant mortality. 21 The mechanism at work have not been identified clearly and the effect of socio-economic status of the housenold or income is difficult to isolate. 3owever, it is hypothesized that the literate of educated mothers probably recognize the problems earlier, seek the available assis- tance sooner and/or use the prescribed treatment better or more faithfully than the illiterates. Educated mothers are also said to be less fatalistic but that is a function of both the level and content of education. A study of the regional variations in rural infant mortality rates shows maternal literacy to be influencing neonatal mortality (deaths up to four weeks of 1/ S. Sahni and R.K. Chandra, "Malnutrition and Susceptibility to Diarrhea; with Special Reference to the Antiinfective Properties of Breast Milk," in: Diarrhea and Malnutrition: Interactions, Mechanisms and Interventions, Lincoln C. Chen and Nevin S. Scrimshaw, eds., New York: Plenum Press, 1983, pp. 1-19. 2/ Helen Ware, "Effects of Maternal Education, Women's Roles and Child Mortality", Population and Development Review Supplement to Vol. 10, 1984, pp. 191-214. -129- age) through birth attendants being more likely to be trained. 1/ The development literature postulates a link also between literacy and education and the level of productivity, although the apparent link may reflect association between literacy, income and control of resources. Further, their illiteracy notwithstanding, farmers do respond well to effective exten- sion services such as the training and visit system that has been instituted in several States of India. Insofar as exploitation is a cause of poverty, mere literacy or primary education does not really equip an individual to assert his rights. 53. The Bank's 1984 Report had noted the relatively slow progress of India with respect to Literacy and the goal of universal school enrollment of children up to age 14. The 1981 census has estimated 58 and 38 percent of boys and girls 6-14 to be attending school; and only 55 and 26 percent of males and females aged 15 and over were literate. Kerala had the highest adult (15.) literacy rates of 86 and 71 percent in 1981. Literacy among women is considered an important variable influencing both infant mortality and fertility. An inverse relationship between literacy and primary educa- tion among mothers and KIR has been cLearly indicated by the 1978 Survey of infant and child mortality. Likewise, several Indian studies have suggested a clearly lower fertility among women who have studies beyond the primary school. In recognition of the critical importance of female education the Central Government has recently decided to make education for girls up to high school free, but school fees represent only a small part of the total cost of schooling. Perhaps more important than the direct cost is the oppor- tunity cost of time in the form of either the earnings forgone or the care of younger siblings. Indeed a major reason for non-enrollment in or dropping out from schools is said to be the need for supplement the modest household income. However, in 1981, only about 30 percent of the children aged 10-14 and not attending school were reported to be working. The percentage was much lower (20) among girls (who tend to help in the house work) than among boys (43). Since children who study for less than 4 years relapse into illiteracy, India's objective of eradicating illiteracy continues to be frustrated. 54. India's National Adult Educaticn Program continues to aim at eradicating illiteracy among adult in the age group 15-34 by 1990. 2/ However, the NAEP's procedure requiring illiterate adults to attend classes for two hours each day (often after a gruelling hard day at work) for a continuous period of 10 months are unrealistic demand overambitious in the 1/ Anrudh Jain, "Determinants of Regional Variations in Infant Mortality in Rural India," a paper presented at a Seminar on the Determinants of Infant Mortality in India, held at Ahmedabad, October 1-4, 1984. 21 Planning Commission. The Approach to the Seventh Five Year Plan, 1985-90, New Delhi, 1984, p. 26. -130- scope of the syllabus and they overlook the low motivation among the learners and the inadequate training and acceptability of the instructors. It remains to be seen whether the Indian Planners can overcome these constraints by designing an effective program, perhaps with the involvement of newly intro- duced mass media with their extensive appeal. -131- WORKING PAPER V DEVELOPMENTS IN ENERGY Prepared by Peter K. Pollak -132- WORKING PAPER V DEVELOPMENTS IN ENERGY Page No. A. Introduction........................................... 134 B. Adjustment to the Shocks in the 1970s......................... 135 C. Increases in Domestic Energy Production.......0....66......... 139 The Increase in Domestic Oil and Gas Production............... 139 The Increase in Coal Production.........e..................... 141 The Increase in Power Generation..o.......................... 144 D. Management of Energy Demand...... ...... .. ...... . ......... 150 Decline in the Energy Intensity of the Economy................ 156 Changes in the Demand for Energy.eoewe........ .......... 158 E. Energy Issues for the Future......... .... . ..... ... .... ...... 159 Growing Fuelwood Deficit...................... 00 ........ ... 160 F. Prospects for Oil Imports in the 1990s..........e-........... 161 Demand Prospects............................................. 161 Potential for Increasing Oil Production....................... 161 Potential for Reducing Oil Consumption.......o........ oo....w. 162 Tables V.1 Net Imports of Crude Oil and Oil Products.................... 136 V.2 Resource Generation in Manor Energy Sub-Sectors, 1975/76-1981-82........... .............................. 139 V.3 Oil Reserves and Production, 1972/73-1983/84................ 140 V.4 Coal: Plan Targets and Output, 1973/74-1983/84.............. 142 V.5 Power: Installed Capacity, Plan Targets and Utilization, 1970/71-1983/84...........*..... ...S... 146 V.6 Average Gestation Periods for Electric Power Plants During 1980/81-1983/84.............................. 148 V.7 Performance of Thermal Power Plants................... 149 V.8 Users of Kerosine by End Uses and by Income.................. - 151 V.9 Comparison of Domestic and International Prices - Crude Oil and Selected Products, 1971-1983..6............. 152 V.10 Economic Taxes on Consumption of Selected Petroleum Products......................................... 154 -133- Page No. V.11 Coimmercial and Mon-Comuercial Energy Consumption and Facrgy intensities, 196%a-82 .. ................ ... .... . ...... 157 V.12 Energy Batances for 1972, 1978 and 1982 ...................... 159 V.13 Production7 Demand ani Net Imports of Crude Oil and Petroleum Products, 1980/81-989/089190........... 162 Figure V.1 Oil Consumption and Imports .................................. 137 -134- WORKING PAPER V 1/ DEVEDPHMENTS IN ENERGY A. Introduction 1. The contribution of the energy sector to India's CDP has been growing rapidly. In terms of gross value added, commercial energy production (oil, gas, coal and electric power) accounts now for just under 4% of CDP, compared to 1.8% in 1973/74. Over the past ten years, the contribution of hydrocar- tins and coal, which amounted earlier to only 40% of the total, haa increased to almost 60%. 2. Despite the still modest contribution of commercial energy to GDP, the total energy sector plays a major role in the Indian economy. Net petroleum imports are equivalent to 2% of CDP, and are equal to over 40% of net export earnings. As commercial energy now accounts for only some 60% of total eiergy consumption (Lee below), the total share of energy in CDP is considerably higher than the 4% share of commercial energy. 2/ 3. Although households consume more than half of India's energy supplies, most of it is in the form of non-commercial fuels. Oil products, coal and electricity account only for about 10% of household energy consumption. Thus, the bulk of the commercial fuels is consumed by the industrial sector (33%), the transport sector (17%), the agricultural sector (2Z), and in energy transfer costs and losses (37%). 4. The composition of fuel consumption has increasingly shifted from the use of non-commercial fuels, mainly fuelwood and agricultural wastes, to commercial fuels. In the early 1970s, the relative shares of these two groups of 2uels were about equal. At present, non-commercial fuels account for less than 40% of total energy consumption, while coal accounts for 32%, oil and gas for more than 20% and primary electricity for about 8%. The bulk of the substitution of non-commercial fuels has been in the form of coal and oil products, essentially reflecting two important factors: (a) India's large coal resources; and (b) the rapid growth of road transport, where energy use in the form of petroleum products has almost doubled over the past decade. The increasing reliance on couercial fuels has strained the capability of the energy sector to meet the energy needs of the economy and has placed a heavy burden on the balance of payments. 1/ This Working Paper, together with six others, supports the analysis in Chapter 2 cf the Report, India: Structural Change and Development Perspectives, Report No. 5593-IN, dated April 24, 1985. 2/ These consumption shares are based on Btus, not price; as the cost per Btu of non-commercial energy is often lower than that for commercial energy, the 40/60 ratio cannot be directly used to estimate the total energy share in GDP. -135- 5. Concerned about the adverse impact of energy shortages on economic growth, the Government has continuously stepped up investments in the energy sector. While the steep increase in the share of total public investment in the energy sector from 16% in 1973/74 to 28% in 1983/84 reflecte to a large extent the Government's response to the increase in international oil prices, it is also in ine with the traditional perception that the energy sector must provide the Indian economy with the energy it requires to sustain growth. 6. Against this background of the vital role which energy plays in the development of the Indian economy, this annex (a) analyzes the efforts that the Government has made to respond to the oil shocks of the aeventieb through increased domtstic production of oil, gas, coal and power and through better management of the domestic demand for energy and (b) outlines the key issues facing the Government in the future in two of the most critical energy areas- -petroleum and fuelwood. B. Adjustment to Shocks in the 1970s 7. During the 1970s the Indian economy was buffeted by a series of external and internal shocks. Within a relatively short time span, interna- tional oil prices increased from US$1.40 in 1970 to US*34.30 per barrel in 1981. At the same time India experienced severe droughts, which affected not only agricultural production, but also the output from hydroelectric power stations. On top of that, civil strife in Assam in 1980 led to a drop in domestic oil production. 8. The immediate impact of the oil price shocks was a sharp increase in the import bill for crude oil and petroleum products (Table V.1). This bill reached a peak of 78.5% of export earnings in 1980/81. The increase in domestic oil production--from 7.2 million tons in 1973/74 tc 26.0 million tons in 1983/84--together with the effects of the Government's conservation efforts contained the growth in the volume of crude and petroleum product import so that the growth in the oil import burden reflects mostly tne increase in international oil prices. 9. In many respects India's response to the increase in international oil prices was similar to that of other oil importing countries To ease the heavy burden of oil imports the Government adopted a two-pronged strategy. First, in order to increase domestic energy supplies, the Government allocated a larger share of available resources to the exploration and production of oil, coal and power generation and implemented policies supporting this effort. Second, to restrain oil consumption, the Government introduced a series of measures to reduce the overall growth in energy con- sumption and replacing oil products with other fuels in as many end-uses as economically and technically feasible. In implementing this strategy the Government relied on the recommendations of advisory committees. In Fome cases, the recommendations were overtaken by events, making it necessary to -136- appoint another comittee. For example, the report of the Fuel Policy Committee was issued at about the time of the first oil price shock. Since its recommendations were no longer appropriate given the change in market conditions, the Planning Commission set up the Working Group on Energy Policy. After the second oil price shock, the Government reached the conclu- sion that energy had become the most critical sector in the management of the country's economy. It therefore set up a high level Advisory Board on Energy, whose chairman reports directly to the Prime Minister. The work done by the Board thus far has concentrated largely on short-term measures and medium-term perspectives, particularly with respect to the formulation of the Seventh Five-Year Plan. 1/ 10. In judging the effectiveness of India's adjustment efforts in the energy sector, it is important to keep several points in mind. First, many changes in the structure of investments, and in the institutional as well as policy framework had been initiated well before the first oil price shock. The sudden and steep increase in the cost of imported petroleum provided the incentive to accelerate decisions on matters that Table V.1: NET IMPORTS OF CRUDE OIL AND OIL PRODUCTS 1973174 1978/79 1983/84 Crude Oil Imports (million tons) 13.9 14.7 11.0 Oil Product Imports (million tons) 3.4 3.8 2.7 Oil Product Consumption (million tons) 23.6 a/ 29.7 a/ 37.8 a/ Memo Item3 Share of Oil and Oil Equivalent of Product Imports in Oil Prod. Cons. (%) 73.3 62.3 36.2 Value of Oil and Oil Product Imports as Percent of Export Earnings (Z) 21.1 29.3 34.3 Source: Indian Petroleum and Petro-Chemicals Statistics, 1983/84 a/ Includes r7fining fuel and losses. had been under consideration for years (Figure V.1). Many of the adjustments in the energy sector during the 1970s can be traced back to farsighted recom- mendations of various committees and working groups. The Energy Survey of India Committee, for example, pointed out in its report in 1965 that 1/ The various Five-Year Plans have derived their approach and basis for energy policy and planning from the recommendations of some of these committees and groups. -137- Figure V.1 OIL CONSUMPTION AND IMPORTS Million Tons Dtestic Refining of iDcmetic Cdy- .X \ KCuze Lmportea' Produet Equivalent a-4 i4 Product 71 7 7 I7 7 71. 72 73 74 75 76 77 78 79 80 81 82 83 -138- indigenous oil supplies would not be sufficient to meet more than a rela- tively small fraction of India's expected demand, and that India would have to import a large share of its oil requirements unless exploration efforts reault in major discoveries. The committee stressed in particular the heavy burden of likely future oil imports, and projected that oil imports would amount to 38% of total imports by 1980/81. Second, the results of many of the decisions taken in response to the oil price shocks will become evident after considerable time lags. Energy conservation usually entails replace- ment of retrofitting of existing capital goods. Since the average economic life of capital goods may be as long as 15 to 20 years in India, the observ- able impact today of conservation measures and pricing policies adopted after the two oil price shocks is naturally somewhat limited considering that only five years have elapsed since the second oil price shock. Finally, the use of cost-plus pricing tends to reduce the incentive to implement energy con- servation measures as fuel price increases can be passed on to consumers in the form of higher prices. 11. A key factor in the overall success of the Government's strategy was the discovery of the Bombay High oilfield in 1974. This led not only to a steep increase in domestic oil production, but provided the Government with financial -esources for investments in the two major non-oil energy industries, power and coal, as well as in the rest of the economy (Table V.2). Both sectors were thus able to increase their capacities and output at rates well above those achieved before the first oil price shock. However, rising ICORs, increasingly longer gestation periods in the implemen- tation of projects and a gradual deterioration in the utilization of existing capacities are evidence of the energy sector's growing difficulties in trans- lating the massive inflow of resources into a commensurate increase in output of coal and power. The root of these difficulties is in the institutional and policy framework within which the energy sector operates in India. Thus, the main lesson that can be learnt from the adjustment efforts to the two oil price shocks is that a further acceleration in domestic energy production can only be achieved if the increase in financial resources made available to the energy sector is paired with institutional and policy changes that aim at a more efficient utilization of these resources. In the oil sector, of course, the risks and uncertainties inherent in oil exploration have been a very major bottleneck to higher output. Considering that it will be difficult to increase further the current share of the energy sector in total investments, the Government is likely to face difficult choices in the years ahead both in decisions of sub-sectoral investment allocations and appropriate institu- tional and policy changes. For the energy sector to provide the energy resources needed to sustain an economic growth of 5% per year without undue hardship for the poor and without an increase in India's dependence on imported energy, a drastic change in the basic thrust of India's current energy policy will not be required, but rather a careful assessment of the extent to which investment allocations in the various sub-sectors and changes in existing energy-policies, particularly pricing policies, would contribute towards this goal. -139- Table V.2: RESOURCE CENERATION IN MAJOR ENERGY SUB-SECTORS 1975/76 - 1981/82 (Percent of Investment) a/ Oil & Gas Coal Power Total Sector 1975/76 671.0 - 34.4 - 1976/77 662.8 26.1 35.9 127.9 1977/78 609.5 40.4 33.4 134.8 1978/79 641.9 -20.9 42.0 138.1 1979/80 843.8 35.5 29.7 137.4 1980/81 530.8 41.6 29.4 113.2 1981/82 421.0 63.3 34.2 132.4 a/ Estimated from summary capital accounts published in NIS. Source: Annual Reports on ONGC, OIL and Department of Petroleum. 12. Lessons that can be drawn from policy actions and developments in the various energy sub-sectors provide guidance for further adjustments in these sectors. The following paragraphs will therefore focus on the lessons from the Government's adjustment efforts in the oil and gas, coal, and power sectors during the 1970s, and from its energy demand management efforts. C. Increases in Domestic Energy Production 13. The Increase in Domestic Oil and Gas Production. By the time of the first oil price shock, domestic oil production averaged 7.2 million tons and supplied about one-third of domestic oil consumption. Proven reserves amounted to 127 million tons and were expected to last for 18 years at this production level. As a result of substantial increase in investments in the industry, in particular for exploration and field development, oil production rose to 26 million tons and proven reserves exceed now 525 million tons (Table V.3). 14. The dramatic increase in domestic oil output and reserves is largely the result of the Government's decision to substantially increase the resour- ces for oil exploration and field development after the first oil price shock. A major role was clearly played by the increased output from Bombay High. The field was discovered in 1974 and was brought under production in 1976. Although the discovery of Bombay High took place before the first oil price shock, without a massive increase in investments it would not have been possible to bring the field on-stream in such a short time; it would also not have been possible to raise overall oil output so rapidly without stepping up of exploration efforts and subsequent increase in reserves. Thus the fact -140- that it proved possible to increase petroleum production rapidly through timely investment in exploration and field development is perhaps the most important lesson that can be learnt from the adjustment experience in the oil and gas sector. Table V.3: OIL RESERVES AND PRODUCTION, 1972/73-1983/84 As on Balance 1st Recoverable Year-to-Year Reserves to Oil Production January Oil Reserves Change Prod. Ratio a/ lin Targets Actual ------(million tons)- -(Years-- -_---million tonsF-- 1972 125.2 - - - (7.3) 7.4 1973 127.3 2.1 17.2 - (7.2) 7.2 1974 124.5 2.8 17.3 - (7.7) 7.5 1975 143.9 19.4 19.2 - (8.5) 8.3 1976 275.5 131.6 33.2 - (8.9) 8.7 1977 303.2 27.7 34.9 - (10.8) 10.2 1978 347.0 43.8 34.0 - (11.6) 11.3 1979 354.4 7.4 31.4 - (11.8) 12.8 1980 366.3 11.9 28.6 (13.1) (10.5) 9.4 1981 468.5 102.2 49.8 (16.9) (16.2) 14.9 1982 470.8 2.3 31.6 (20.5) (21.1) 19.7 1983 526.3 55.5 26.7 (21.3) (26.0) 25.1 1984 510.8 15.5 20.4 Source: Indian Petroleum and Petro-Che=ical Statistics. al Reserve production ratio is based on recoverable oil reserves as on 1st January of each year and production during the preceding calendar year. Figures in brackets quoted here are in terms of financial year. 15. During the Fifth Plan total expenditure for the exploration, development, refining and distribution sector reached Rs 19.6 billion. Of this ONCC received Rs 13 billion, or 66%. Under the Sixth Plan outlay on exploration for oil and gas and field development was originally raised by 65% in real terms over the outlays under the Fifth Plan. The Sixth Five-Year Plan was largely finalized before the second oil price shock in 1979/80. The second sharp increase in international oil prices coincided with a drop in indigenous production due to the unrest in Assam. Both these events led to a reassessment of India's exploration and production strategy. The Government decided to further step up oil exploration and production and substantially -141- increased the Plan allocation for exploration over what had been originally envisaged in the Sixth Five-Year Plan. 16. The number of prospective areas, both onshore and offshore, exceeds ONGC's and OIL's combined exploration capacities. In 1980 and 1981 the Government decided to open up selected prospective areas to foreign explora- tion companies under production sharing contracts. The foreign contractors were to explore at their own risk and, should they find commercially exploitable hydro-carbon reserves, share the output with the Government under terms agreed in the contract. Discussions were held with 22 foreign firms in December 1980 and January 1981 concerning 32 exploration blocks onshore and offshore covering over 600,000 sq km. Foreign companies did not respond enthusiastically to these offers, and the Government faces now the choice either to intensify exploration efforts in less promising areas through a greater investment allocation to ONGC or to allow foreign oil companies to play a greater role in this area by offering more attractive terms in produc- tion sharing agreements. 17. As a result of ONC's and OIL's exploration efforts, crude oil reser- ves have increased four-fold since 1973/74 (Table V.3). According to the latest estimated by the ONCC/OIL, prognosticated reserves in the sedimentary basins of India are placed at 17.0 billion tons of oil and oil equivalent of gas. Almost 60% of the total prognosticated reserves are estimated to be located offshore. The proved recoverable reserves of oil are currently around 500 million tons. These reserves are located mainly along the west coast in Cambay and Bombay High basin and in the north-east region, par- ticularly in the upper Assam Basin. 18. The discovery of relatively large natural gas reserves, which have remained largely untapped, provides India with yet another option to reduce oil imports and to meet the growing energy needs of accelerated economic growth. Up to now, natural gas has been largely reserved for use as a feedstock in fertilizer production. This policy, which was formulated when natural gas reserves were comparatively small, needs to be reviewed in the light of recent additions to gas reserves, a runaway demand for middle dis- tillates and persistent power shortages that affect in particular industrial growth. 19. The Increase ia Ceitl Production. Coal has traditionally played a dominant role in the domestic suppiy of commercial energy in India. Even before the sharpD increase in international oil price: resulted in an all-out effort to shift to coal and away from the use of petroleum products, coal accounted for more than half of all commercial energy consumed in India. Over the years coal production had become increasingly linked to thermal power generation. With the rapid growth of the industrial sector, and the use of electric pumpsets in agriculture, the demand for power began to rise rapidly during the later part of the 1960s. Because of: (a) the considerably shorted gestation period of thermal power plants compared to hydro electric plants; (b) India's highly decentralized industrial location policy; and -142- (c) the lack of a national power grid, the Government decided to accelerate the expansion of thermal power generation. 1/ Considering India's abundant coal resources, most thermal power plants were coal fired. Other fuels, such as fuel oil, were only used if access to coal was difficult. Table V.4: COAL: PLAN TARGETS AND OUTPUT, 1973/74-1983/84 (million tons) Plan Targets Output 1972/73 - 77.2 1973/74 93.5 78.2 1974/75 99.0 88.5 1975/76 98.0 99.7 1976/77 100.2 a/ 101.0 1977/78 108.0 101.0 1978/79 113.5 101.9 1979/80 117.9 103.9 1980/81 113.5 113.9 1981/82 121.0 124.2 1982/83 133.0 130.5 1983/84 142.0 138.2 1984/85 152.0 147.0 b/ a/ Later revised to 99.1. bl Estimate. 20. In 1973 and 1974 the Government nationalized most of India's coal mines. Since September 1975 Coal India Ltd. (along with its subsidiaries) and Singareni Collieries Company Ltd. (which is jointly owned by the State Govt. of Andhra Pradesh and the Government of India and operates the non- coking coal collieries of Andhra Pradesh) control almost the entire coal production in India. About 2.5% of the production of coal in the country comes from TISCO, DVC and the Indian Iron and Steel Company. 1/ Since electricity provides a convenient way to transport energy and the coal-based thermal power stations had to rely heavily on Indian Railways for their coal shipments, a power distribution system and the railway system are to some extent substitutes. -143- 21. In 1973, the bulk of India's coal production came from numerous small coal mines, mostly underground mines that operated at moderate to deep depths. The quality of the coal was low, with an average ash content well above 20%. There was a wide variation in the operating methods of the mines, ranging from pick mining to mechanized methods. Labor productivity was low by international standards. The low profitability of most mining*operations precluded any increases in miners' wages, which in turn led to a high incidence of absenteeism and labor unrest. 22. Nationalization of the mining industry provided the institutional framework for large-scale modernization of mines through the access to modern technology and the expansion of mining capacity. A key factor clearly was the access to public resources. While the decision to nationalize the coal industry was made well before the first oil shock, the overall positive impact of this step on the coal industry was most welcome. Overall invest- ment in the coal industry increased sharply after nationalization. From a modest level in 1974/75, investment more than doubled in 1975/76 and was further increased during the next year. An unexpected drop in demand between 1975/76 and 1976/77, resulted in rising pithead stocks and led to a drop in the investment allocation for 1977/78 and to only a marginal increase in 1978/79. After the second oil price shock, the Plan allocations of invest- ment resources to the coal sector increased dramatically, from Rs 2.5 billion in 1979180 to Rs 8.5 billion in 1983/84. 23. Indian coalfields differed considerably in their potential for short- run increases in output. The coalfields in the Eastern Region are old, many mines are approaching exhaustion, and the infrestructure serving these mines was constructed for a lower level of output. The coalfields in the Central and Western Region are newer, and their servicing infrastructure had con- siderable excess capacity. Investments in the coal industry were therefore directed at reversing the decline in the coalfields of the Eastern Region, mainly by replacing mines that have become exhausted, and at accelerating the growth in coal production in the coalfields of the Central and Western Region. 24. Several factors constrained a more rapid expansion of the investment program in the 1970s. One is the slow progress in land acquisition, which has been particularly troublesome in the Eastern Region, where the collieries faced widespread village level pressures for employment of the people who would be displaced from their land by the opening of new mines. The collieries, however, already being overstaffed were unabie to meet these demands, which made it difficult to adhere to project implementation schedules. These delays have been further aggravated by the slow progress in the infrastructure components of some projects, such as power and rail transport. In particular the gradual deterioration in the railways' capability to move coal has resulted in growing pithead stocks and in a shortage of coal in key industries and thermal power plants. It has also led to the increased use of road transport for coal to supply the demand in the vicinity of coalfields. Still, about 65Z of coal is distributed by rail. -144- Congestion and Limited line capacity in the coalfield areas, the long distan- ces often involved in haulage of coal to the western, north-western and southern regions of the country, the limitations of loading and unloading facilities, poor wagon utilization, and problems of operation including poor Labor discipline on the railways, have contributed to the unreliability of coal supplies. In addition, periodic problems such as shortages of explosives, which affected in particular underground blasting operation, flooding of mines due to power shortages, absenteeism, labor unrest and law-and-order problems resulted in a substantial under-atilization of exist- ing mine capacity in the past. CIL has been actively addressing these problems and making progress, especially in the past two years. 25. As a result of the various efforts that were undertaken following the first oil price shock, the industry wLs able to overcome many of the problems it faced in 1973. Nationalization and subsequent reorganization and recon- struction of the industry played clearly a major role in the vigorous growth of coal output. Up until the mid-1970s, production kept pace with Plan targets and was well ahead of demand. However, during the second half of the seventies, coal production began to stagnate at around 100 million tons. Gradually demand began to outstrip supply and, following the substantial increase in resource allocation to the coal industry in 1980/81, coal produc- tion began to pick up again and coal shortages disappeared quickly. By 1983184, coal production had reached 138.2 million tons (Table V.4). 26. Some of the constraints faced by the coal industry that were noted above, such as the worsening of coal quality, the low productivity of miners and the scarcity of trained personnel for operational and maintenance work are endogenous to the industry. These problem areas are generally being remedied through strengthening the management capabilities of the mining companies. Other impediments to a more rapid growth of the industry, such as continued transport bottlenecks, power shortages, shortages of (imported) spare parts, and delays in implementing price adjustments are largely outside the domain of the coal industry and thus are being addressed from a broader perspective that involves policy changes and adjustments in other sectors as well. 27. The Increase in Power Generation. Despite a quite rapid growth in hydro-electric capacity (averaging about 11% between 1950/51 and 1973/74) and thermal power capacity (averaging 9.7% during the same period), power shortages became increasingly common towards the late 1960s as the demand for power exceeded supplies. At the root of these power shortages were (i) widespread and prolonged delays in the execution of power projects, especially hydro schemes; (ii) operating problems in thermal stations caused by coal shortages, poor and variable quality of the coal supplies, inadequate maintenance, shortage of spares and labor unrest; and (iii) the fact that the States were extremely jealous about their rights over water and at the same time enjoyed a large measure of autonomy in the generation, distribution and pricing of power. All of this hampered regional and national rationalization of the power system and the establishment of national -145- planning, operational and financial standards. So even before the rise in international oil prices, there was a growing appreciation of the need for broader system planning and for a considerable reorganization of the power sector, in particular a strengthening of the role of the Central Government in the sector. 28. In the adjustment of higher oil prices, the power sector provided the Government with three major options: First, by expanding India's hydroelec- tric power generating capacity, the country would gaiu access to its largest reserve of renewable energy resources. Second, by expanding the capacity of coal-based thermal power plants, particularly those located at or near coal mines, the energy contained in coal could be transferred in the form of electricity to a large number of consumers without placing further strains on an already overburdened railway system. Third, thermal power plants using fuel oil or other oil proeacts offered the greatest potential for substitut- ing oil with coal. 29. Faced with growing power shortages, the Government relied increas- ingly on thermal power generation. Between 1973/74 and 1983/84 thermal power generating capacity increased by 173Z, while hydroelectric power generating capacity grew only by 99Z. The shorter gestation period of thermal power plants, the possibility of placing them near major consumers, the lack of an adequate distribution and transmission network and the availability of large coal reserves were among the reasons that tilted the decision in favor of thermal power plants (Table V.5). 30. To reach the ambitious Plan targets and to take advantage of the potential the power sector offered in terms of reducing domestic oil consumption, the Government decided on a significant increase in investment expenditures and a major restructuring of the institutional framework of the power sector. 31. The main thrust of the various institutional changes was aimed at strengthening and expanding the role of the Central Government in the invest- ments for new power generating capacity. To this end, the Government estab- Lished (i) two central generating companies, the National Thermal Power Corporation (NTPC) and the National Hydro Power Corporation (NHPC) to carry out projects that will benefit more that one State; and (ii) the Rural Electrification Corporation as a special financing institution to lend funds to the SEBs for the development of rural electrification schemes. In addition, the Government enacted legislation aimed at supporting the role of the Central Electricity Authority, in particular requiring CPA concurrence with new investments by the SEBs. To further strengthen CEA's role as an overall coordinating agency for investments in the power industry, the Government initiated the drafting of a National Plan for Power Development. To reduce the delays and deficiencies in the supply of new electrical capacity, the Government introduced measures to improve the operations of the Government-owned Bharat Heavy Electricals Limited (BHEL), the principal -146- producer of power eqaipment in India. Finally, the Government adopted a policy of completing on-going projects rather than starting new ones. Table V.5: POWER: INSTALLED CAPACITY, PLAN TARGETS AND UTILIZATION, 1970/71 - 1983/84 Additions to Total Trane. & Total Capacity Installed Capacity Power Plant Distri- Plan Captive Gener- Load bution Targets Actual Total N dro Nuclear Thermal ?ower ation Factor Losses a/ --- - - -------- M---- ----- G 1971/72 N.A. N.A. 16890 6612 420 8223 1635 66384 - 17.5 1972/73 N.A. 1099 17989 6785 620 8876 1708 70516 - 18.8 1973/74 9264 4579 18456 6965 640 9058 1793 72796 50.4 19.9 1974/75 2163 1720 20346 7529 640 10148 2029 76679 52.7 20.5 1975/76 2663 1793 22249 8464 640 11013 2132 85926 52.1 20.2 1976/77 2406 1705 23756 9025 640 11804 2287 95615 55.4 19.4 1977/78 2596 1956 26174 10020 640 13008 2506 98928 50.9 19.8 1978/79 3857 3022 29298 10833 640 15207 2618 110130 47.9 19.5 1979/80 2813 1799 31308 11384 640 16424 2860 112820 44.3 20.0 1980/81 2687 1823 33315 11791 860 17563 3102 119261 44.2 20.5 1981/82 3212 2175 35780 12172 860 19312 3436 130570 46.4 20.6 1982/83 3482 3060 39248 13055 860 21448 3885 139010 49.4 20.8 1983/84 4157 4088 43735 13853 1095 24412 4375 148621 47.9 20.9 a! Transmission and Distribution Losses as a Percentage of Energy Delivered to the bus bar. Source: Annual Report, Department of Power; CHIE (August 1984): The Power Scenario - A Study, Association of Indian Engineering Industry, July 1984, New Delhi. 32. The power sector receives the largest share of public investment among the various energy subsectora-around 60Z in 1983/84 (Statistical Annex Table 5.11), around 55Z in 1983/84. In terms of outlays on power as a per- centage of CDP at current factor cost, it has moved from 2.1Z to 2.32. Since 1973/74, as in the past, investment in power generation was slightly more than double the investment in transmission and distribution. In the alloca- tion of Plan resources to the power sector as well as to other infrastructure sectors, maximization of return to investment is not a primary consideration, although the Plan does prescribe a rate of return objective to the operating units. The primary objective of the power sector as well as the other energy subsectors is to provide adequate infrastructura! services to the economy so as not to impair its growth potential, given estimates of future demand. -147- 33. The initiatives taken b; the Government during the 1970s did not succeed in removing all the obstacles to a more rapid growth of the power sector. The shift toward greater reliance on thermal power generation placed a heavy strain on the coal industry and the railways. The rapid increase in coal demand led to the mining of lower quality coal deposits and consequently a deterioration in coal quality, which contributed to increased wear and tear on plant equipment. Improper maintenance and unreliable coal shipments have led to frequent shut downs of power plants. Efforts by the Central Government to reduce power shortages through increased reliance on pithead super thermal power plants were hampered by an insufficient distribution and transmission network, the expansion of which has been neglected in favor of an increase in power generating capacity. Furthermore, the reluctance to raise sufficiently electricity tariffs and delays in achieving major improve- ments in the management of SEBs have contributed to a worsening of their financial position. However, the Government did succeed in setting up an institutional framework, particularly by establishing the two central power generating companies NTPC and NHPC, that made it possible to effectively increase generating capacity and power supplies in many States, without attempting to change the basic structure of the power industry with its heavy reliance on SEBs and on the water rights that States guard so zealously. The success of this increased role of the Central Government in power may have important implications for other sectors which are jointly managed by States and the Central Governmert. This strategy has lead to an increased rate of expansion in power generating capacity and has prevented a worsening of the power shortages. 34. However, the power sector showed some strains in absorbing the con- tinued large flow of investment resources. A survey of the gestation periods of hydroelectric, thermal and nuclear power projects comissioned during the first four years of the Sixth Five-Year Plan found that the average gestation period for hydroelectric power projects (both Center and State projects) had increased from 79 to 145 months (Table V.6). At the same time, the gestation period for thermal power projects has been slightly reduced. Given continued power shortages, the lengthening in the gestation period of hydroelectric power projects is clearly a cause for concern, especially if Government wants in the future to give more emphasis at the margin to hydro and less to ther- mal generating capacity. I -148- Table V.6: AVERAGE GESTATION PERIODS FOR ELECTRIC POWER PLANTS DURING 1980/81 - 1983/84 For Unit Com- Average Gestation Period missioned in Hydra Thermal Gas Nuclear 1980/81 79 83 - 155 1981/82 114 80 56 - 1982/83 113 84 59 - 1983/84 145 74 81 187 Average 121 79 60 171 Source: Planning Commission. 35. The power sector has also difficulties in fully utilizing existing capacities, particularly in thermal power generation. Table V.7 shows the average plant load factors (PLF) for thermal power plants in India. Poor maintenance and technical problems had been the main reasons for the low PLF in most of the power plants, though lack of demand has occasionally been a factor at certain times in some areas. Had sufficient transmission and distribution facilities been available, excess supplies of power in one region, caused by a lack of demand, could have been used to meet an excess demand for power in another region. Special efforts to improve management and staff performance in the past few years, however, have reversed the downward trend in PLF, a most welcome dlevelopment (ref. Table V.7). Further efforts to improve the plant load factors will need to include not only improvements in the operation of thermal power plants, but also arrangements for transferring power from surplus to deficit regions. The advantages of a regional grid system are we!l established- 36. There is a need to maintain the momentum that has been reached in terms of institutional changes, in particular the involvement of the Central Government in the expansion of power generating capacity. In addition, the Government will have to address several priority issues in the years ahead, such as the mix of hydro and thermal power, the development of integrated regional grids and the improvement in capacity utilization in the power sector. 37. Considering India's energy resources, it is clear that new capacity of power generation will have to be based on a judicious mix of coal-based thermal power and hydro-electric power plants. The choice of the mix of thermal and hydel power is closely linked to the allocation of resources for transmission and distribution. Expansion and integration of regional grids would offer several advantages. Improvements in the overall reliability of power supply and the utilization of existing capacities would reduce invest- ment requirements for new capacity. It would make Lhe development of India's -149- large hydro-potential in States like Uttar Pradesh and Himachal Pradesh as well as in the smaller north-eastern States economically advantageous. It would also allow to take advantage of the economies involved in thermal power generation from large pithead plants. Finally, integration of regional grids woul'd ease the problem of peak demand management through the greater access to hydel plants which provide the cheapest source of peaking power and the possibility of sending surplus power from one State to meet the peak demand of aaother. Thus expansion and integration of regional grids will not only increase the overall supply of electric power and its reliability, but do so at a considerable saving of investments in the longer term. Table V.7: PERFORMANCE OF THERMAL POWER PLANTS (Percent) Planned Forced Plant Partial Unavailability Maintenance Outages Availabilit and Lack of Demand PLF 1973/74 19.9 8.8 71.2 20.8 50.4 1974/75 13.2 10.5 76.3 23.6 52.7 1975/76 10.61 13.33 76.06 23.96 52.1 1976i77 9.12 13.11 77.77 22.27 55.4 1977/78 9.58 18.91 71.51 20.61 50.9 1978/79 15.74 15.15 69.11 21.21 47.9 1979/80 12.31 18.76 68.93 24.63 44.3 1980/81 13.31 20.27 66.42 22.22 44.2 1981/82 11.72 19.82 68.46 22.06 46.4 1982/83 11.50 18.50 70.00 20.60 49.4 1983/84 11.25 24.07 64.68 16.78 47.9 1984/85 a/ 8.65 23.82 67.53 17.93 49.6 a/ Source: Central Electricity Authority. a/ April - February. 38. Although plant load factors have improved substantially in recent years, they are still below technically feasible levels, which points to a substantial scope for reducing investments by attaining higher utilization rate. on enisting power plants. A plant load factor of 58% was taken as the target for all thermal power stations in the country by the Committee on Power. Even an inirease in the plant load factor to 56% close to the level that was actually achieved in 1976/77, would be equivalent to the addition to about 3,150 MNW based on thermal power generation in 1983/84. However, it would be unrealistic to expect a dramatic improvement in the utilization of existing plants in the short-term, since the currently low PLF reflects a broad range of inter-related problems, of which a number have been pointed out above. Further improvements in plant utilization will therefore -150- ultimately depend on the willingness of State and Central Governments to work together to improve labor discipline and productivity, to provide good quality equipment, and to assure timely deliveries of adequate amounts of good quality coal to coal-based thermal stations. D. Management of Energy Demand 39. In managing the demand for oil products the Government relied heavily on pricing policies.1/ As a result of fuel shortages, energy pricing policies, and other conservation measures, the growth rate of total energy consumption and of the energy intensity of the Indian economy slowed down. 40. Prices of domestically produced fuels, like those of Pny other commodity, should theoretically reflect the opportunity cost of the resources required to produce the marginal unit of fuel if it is non-tradeable, or its border price if it is traded internationally (leaving aside using fuel prices for taxation). In practice, however, energy pricing policies are aimed to achieve multiple and often conflicting objectives. India's energy pricing policy has been no exception. In addition to promoting the efficient use of energy resources, the pricing policies for the various fuels aim at: (i) meeting the minimum energy needs of low income consumers; (ii) encouraging the shift from oil products to domestically produced fuels to reduce the dependence on oil imports; (iii) providing energy at prices that will lead to an expansion of production without a commensurate rise in output prices; and (iv) promoting price stability, and avoiding frequent, abrupt or massive adjustments in fuel prices. Current pricing policies represent a compromise between the goal to use fuel prices for efficient energy demand management and the need to meet some of the above socio-economic objectives. Without doubt these competing objec- tives have considerably reduced the effectiveness of energy pricing as a tool of energy demand management, as the following discussion of pricing policies and their impact on energy consumption shows. 41. The key to the efficient use of domestically produced and imported crudes are the pricing policies for petroleum products. While the prices of 1/ With respect to the other major fuels, power and coal, pricing policies had i comparatively smaller impact on their demand. Over the period under consideration, demand for power has been largely supply constrained. Except for a few years during the late 1970s, the same has also been true for coal demand. -151- domestically produced crudeE-both f-om onshore as well as offshore fields- are considerably below CIF prices of imported crudes (Table V.9), all petroleum products, with the exception of Verosene and naphtha, are priced well above their corresponding import parities. At these levels, petroleum product prices assure not only the financial viability of crude production and refinery operations, but also the continued contribution of the petroleum sector to public resource generation. This policy was continued as the 1985/86 Central Budget which raised petroleum prices by an average of 15%. 42. Since almost 80% of naphtha supplies ari used by the fertilizer industry, the main rationale for pricing naphtha below import parity is to contain the cost of fertilizer production. During 1979-82 diesel oil was also priced below its CIP import parity, mainly to avoid adulteration with kerosene and to contain the cost of road transport. Kerosene prices have been kept low mainly for social reasons. Kerosene is mainly uaed in urban areas for cooking and in rural areas for lighting. As Table V.8 shows, the use of kerosene declines with an increase in income, both in rural and urban areas. It also shows the heavy dependence of low income households on the availability of (inexpensive) kerosene. Table V.8: USERS OF KEROSENE BY END USES AND BY INCOME (Z of households) Income Class Coking Lighting Total (Rs) Rural Urban Total Rural Urban Total RuraL Urban Total Up to 3,000 3.5 23.6 6.2 97.4 80.9 95.2 98.5 91.2 97.6 3,001 - 6,000 7.4 45e6 17.8 53.2 57.8 83.6 95.8 83.6 92.5 6,001 - 12,000 10.2 59.7 29.5 88.9 38.8 69.4 91.9 81.5 87.8 12,001 - 18,000 12.5 64.0 34.0 81.3 29.4 59.7 J5.9 79.6 83.3 Over 18,000 15.9 67.7 39.9 84.1 22.8 55.7 89.1 78.3 84.1 All 5.6 43.1 13.9 95.0 59.0 87.0 96.8 85.2 94.2 Source: National Council of Applied Economic Research. 43. In setting petroleum prices, the Government assures each refinery a 'retention price' per ton of crude equivalent that covers total refinery costs plus a 15% return on capital. The costs include crude oil and operat- ing costs at efficient operacion level, defined for each refinery. The unit crude oil cost to the refinery is notionally computed as the weighted average price of local and imported crudes processed by all refineries taken together. The difference between the computed notional crude oil price to the refinery and the actual prices paid by the individual refinery for its crude oil procurement is adjusted among the refineries periodically, under the crude oil price equalization account of the Oil Coordination Committee (OCC). Central Government taxes added at the ex-refinery level are fully ТаЬ1е У,9; COКPARI80N ОР DONEBTIC AND IЧTRRNATIONAL PRICBB CRUDB OIi. АliD BBLEC'fED PAODUCTS� 1971 - 1983 On 8Ьоге Crude Off 8hore Сгиде _ Бк-8tогеУе 8osbav . CIP ВовЪаv D�дeвtic_Ргiсев_ iя Percent of CIP Ргiеев �аве Iдс1. Сеев Dae� Inc1. Севв Fue1 Рие1 Уеаг Price Ь Bova1CY aI Ptice Ь Qovalty е/ Ceeolioe Rеговеае Dieвel Oi1 Сгиде Ceeoline Rerotene Dieвel Сгиде Савоliпе Rаховеее Diaвel Oi1 (08$ / И1') (д) 1971 - - - - 216 8Э 109 34 - - - - - - - - - 1972 - - - - 212 87 107 за 1в а1 зб 27 - 517 2аг э96 п27 197Э - - - - 260 93 109 Э5 �4 54 46 37 - 481 202 295 175 1974 - - - - 488 135 123 78 82 127 108 94 - Э84 125 191 120 1975 31.84 31.Я4 - - 467 1Э8 128 94 81 147 120 121 39 318 113 106 134 1976 29.55 31.77 - - 449 151 142 109 86 158 131 114 3k 284 115 145 1S1 1977 27.93 35.27 - - 460 155 145 112 93 166 1Э9 122 ЗО 277 112 119 144 197а г9.19 эб.8о з9.95 s2.2s 49а 1ва i5a 11в 9s 168 1а5 12ч зi 29а 11з 1i9 1а8 1979 29.85 37.66 40.90 5Э.47 605 189 17В 142 136 2Э8 202 182 22 254 • 44 98 130 1980 30.44 Э8.46 41.79 54.62 726 201 244 220 221 Эб7 343 309 14 197 59 79 120 1981 70.60 8R.88 77.97 94.27 ТОЗ 183 283 253 260 398 386 Э42 27 177 47 В3 117 1982 105.46 122.11 105.4б l22.11 759 197 Э15 275 245 Э80 377 336 43 200 52 94 1Э9 1983 101,48 135.69 101.48 135.69 731 200 322 274 215 341 323 289 47 211 62 111 145 � r и и �/ Includes Oi1 Davelopmenc Севе, Royalties and 8а1ев Так. � J Dевв price ��f onshora ctude ав реrседС of CIP ВотЬау стиде ргiсев. 8 uQ ксе: Iadian Petroleum аад Petrocheвical 8taCilвCicв; Есоповiс Апаlувi■ апд Pгojectioдe Department� Чог1д 8вnk. -153- included in the sale prices. Prices at major distribution points include, in addition to the ex-refinery pricesp Government taxes and a margin to cover the distribution costs and distributors profits. Retail prices include other State Government and local taxes, and additional transportation costs. Table V.10, which compares the domestic wholesale and c.i.f. prices of key petroleum productsv illustrates two important effects of India's pricing policy of petroleum products. Onev the margin between border prices and domestic wholesale prices has shrunk over the past ten years; and two, the subsidy on kerosene is more than compensated by che implicit tax on other major fuels. 45. While absolute price levels of petroleum products have been an effec- tive tooL in resource generation and the overall mangement of energy demand, there is a need to review the prices of petroleum products in relation to each other. In this context top priority should be given to a review of the relative prices of diesel oil and gasoline. The ratio of the retail prices of diesel and gasoline averages 0.52 in India, 0.68 in Turkey, 0.63 in Thailand and 0.77 in the U.S. Although diesel-fueled transportation is regarded more efficient and economic than that fueled by gasoline, the value of increased use of diesel oil at a low relative price needs to be weighed against relevant economic costs which include the costs of diesel oil import, exporting surplus naphtha/gasoline products at low border prices, and invest- ment in secondary conversion units which increase the yield of diesel oil. 46. Coal prices have been set by the Government since 1941 (except between 1967 and 1974). Since the nationalization of non-coking mines in 1973, average pithead prices of coal have been based on an industry-wide average cost of production. Coal is classified into 13 different grades depending on coking quality and ash content for coking coals and useful heat value for thermal coals. Since nationalization of non-coking mines, coal prices have been revised on six occasions: in April 1974, July 1975, July 1979, February 1981, May 1982 and January 1984. 1/ (A further review is scheduled for April 1985.) However, in most of Ehese price adjustments, actual average production costs were not fully reflected in the price increase for one or more of the following reasons: M exclusion of return on capital and/or depreciation from average cost of production estimates; and (ii) inadequate allowance for increases in cost of inputs between price adjustments. Despite the increases in coal prices, Indian coal is priced well below internationally traded coal, even if the comparatively low calorific value of Indian coal is taken into account. -154- This pricing policy has led to Large losses by Coal India Limited (CIL) in the period 1974/75 to 1979/80. Since almost half of India's coal production is used by the power sector, higher electricity tariffs would help pave the way for further increases in coal prices. There is a need for a revision of the pricing mechanism, in particular the timely upward adjustment of coal prices. Table V.10: ECONOMIC TAXES ON CONSUMPTION OF SELECTED PETROLEUM PRODUCTS (billion Rupees) Gasoline Kerosene Diesel Fuel Oil Current 1970/71 Current 1970/71 Current 1970/71 Current 1970/71 Prices Prices Prices Prices Prices Prices Prices Prices 1973/74 2.9 2.1 1.1 0.8 2.5 1.8 0.3 0.2 1974/75 3.5 2.1 0.6 0.4 1.2 0.8 0.7 0.4 1975/76 3.4 2.2 0.5 0.3 0.7 0.4 1.4 0.9 1976/77 3.4 2.0 0.5 0.3 1.6 0.9 1.8 1.1 1977/78 3.6 2.0 0.5 0.3 1.6 0.9 1.7 1.0 1978179 4.0 2.2 0.3 0.1 1.1 0.6 1.7 1.0 1979/80 4.3 2.1 -1.4 -0.7 -2.5 -1.2 1.2 0.6 1980/81 4.7 2.0 -4.9 -2.1 -3.1 -1.3 3.6 1.5 1981/82 5.8 2.3 -7.4 -2.9 -1.1 -0.4 5.0 2.0 1982/83 7.9 2.9 -3.9 -1.4 7.7 2.8 9.1 3.3 Note: Taxes are calculated by subtracting the border price from the domestic wholesale market price. Thus a negative sign indicates a subsidy. 47. Each State Electricity Board (SEB) decides on the level and structure of electricity tariffs in its State, which reflect the specific priorities of State Governments. The Central Government, through its Central Electricity Authority (CEA) plays only an advisory role. Most States sell electricity to agriculture and power intensive industries (aluminum, cement, etc.) at preferential tariffs, while other industrial, comercial and domestic con- sumers usually receive electricity at considerably higher tariffs. By providing agriculture with inexpensive electricity, State Governments encourage expansion of irrigation and thus growth in agricultural output independent from the vagaries of the monsoon. The main argument for preferential tariffs to power intensive industries is to create employment opportunities in such industries. 48. The tariff structures applied by the various SEBs do not allow for seasonal variations in the cost of power generation nor does their cost structure differentiate between base and peak load demands. Most SEB tariff -155- structures contain a 'power' charge and an 'energy' charge, that is, the user's rate depends (i) on the maximum EU load he consumed during the billing period; and (ii) a flat rate per KWh. This is an improvement over a simple flat rate tariff, but as system peak-load demand and the peak demands of individual consumers do not necessarily coincide, this tariff structure does not necessarily assure that power tariffs reflect actual system costs. 1/ 49. The average tariff charges by most SEBs are below average cost and well below estimates of long-run marginal cost. Despite increases in tariffs, particularly to industrial and commercial consumers, average tariffs have fallen in real terms over the past two decades. They have also declined relative to the prices of other iuels. This has greatly zffected the finan- cial performance of the SEBs, which are financed principally through loans from their respective States. The worsening revenue situation h.ee made it increasingly difficult for them to repay these loans or even to pay interest on them. To remedy the situation the Government amended the financial provi- sions of the 1984 Electricity (Supply) Act in June 1978 by introducing finan- cial policies that are more in line with commercial principles. The amend- ments dealt with issues such as proper debt servicing of State Government 1/ The cost of sophisticated metering may be prohibitive for most of the small commercial establishments and farmers. However, for large industrial users, which account for a major portion of the load, the structure of tariffs could be set to reflect peak costs, and the simple energy charges to small consumers could be raised to cover more of the costs of system expansion from peak users. Load management techniques using this kind of pricing incentives, as well as administrative measures, are now being discussed in India to control the impact of shortages. -156- loans, the achievement of reasonable levels of self-financing and the intro- duction of the concept of equity share ceapital.1/ 50. The underpricing of electricity has also contributed to the rapid growth in electricity demand, particularly in the agricultural sector, and has thus played a major role in the chronic power shortages.2/ There is thus a need to review the pricing policy for power. It is unlikely that the financial position of the SEBs could be strengthened without a substantial increase in electricity prices. 51. In addition to these pricing policies the Government adopted a wide variety of energy conservation measures. While it is difficult to ascertain with any degree of accuracy the relative effectiveness of these measures, it could certainly be argued that the various fuel pricing policies played a major role in slowing the overall growth of energy demand and in changing the relative importance of fuels in key sectors of the economy. 52. Decline in the Energy Intensity of the Indian Econemy. The energy intensity of the Indian economy-in terms of tons of oil etuivalent of com- mercial energy per million US dollars of GDP--grew at an average of 2.8% a year between 1960 and 1973. In the years following the first oil price shock (1973-79) this rate dropped to less than 0.5%, averaging about 1% for the period 1973-82 (Table V.11). If the use of non-commercial energy is included, the growth rates for the periods 1960-73 and 1973-82 average 0.5% I/ However, the implementation of the financial amendments have been delayed until the recommendations of the high level committee (Committee on Power), that looked into all aspects of power industry including financial performance of the SEBs are published and discussed. Nevertheless, action was taken by many SEBs in introducing programs designed to improve their financial performance. These have been rela- tively successful in that, out of the 14 major SEBs, 11 reached or exceeded their 9.5% rate of return target in 1978/79. There is, however, a wide variation in the performance among SEBs. The poor performance of some of the SEBs, particularly those in the eastern and northern regions, are to a large extent explained by their inability to utilize the market potential to the fullest extent due to poor thermal capacity utilization, political unrest and law-and-order problems. 2/ While some argue that the prices farmers receive for their output have not kept up with rising input prices, and that pricing of electricity at its true cost would squeeze farmers' margins even further, farmers make extensive use of diesel pumps where reliable electricity is not available. The costs of operating diesel pumps is a multiple of the cost of electric pumpsets. Thus, if farmers can absorb the comparatively high costs of diesel operation, they would not be overly taxed by higher tariffs on electricity supplied reliably to them. -157- and -0.05Z respectively. The comparatively faster growth of the intensity of commercial fuel use reflects the increasing substitution of commercial for non-commercial fuels. In 1960 non-commercial fuels accounted for almost 60% of total energy use. By 1982 this share had dropped to about 40%. Table V.11: COMMERCIAL AND NON-COMMERCIAL ENERCY CONSUMPTION AND ENERGY INTENSITIES, 1960-82 Energy Consumption Energy Intensities Commercial Total Energy incl. Commercial Total Energy incl. Ener Non-Commercial Energy Non-Commercial - (million toe) ----- ---(toe per million $ CDP)--- 1960 33.0 80.3 436 1062 1965 48.8 N.A. 500 N.A. 1971 68.1 125.9 577 1067 1972 71.0 129.9 588 1076 1973 74.9 135.4 625 1129 1974 77.6 140.2 625 1129 1975 82.3 146.9 662 1181 1976 88.7 154.8 650 1134 1977 93.2 160.9 675 1165 1978 96.9 166.4 647 1112 1979 101.5 173.5 637 1088 1980 104.8 170.9 691 1167 1981 114.7 189.4 710 1173 1982 116.1 192.2 679 1124 Memo Item: Energy/GDP Elasticities 1960-71 1.7 1.1 1971-82 1.5 1.0 1960-82 1.6 1.1 Source: Energy Balances of Developing Countries, International Energy Agency, Paris (1984); CHIE (August 1984). 53. The slowdown of the growth in energy intensity in the years following the first oil price shock was the result of several factors. First, there was a rather sharp decline in both the share of energy used in the transport sector as well as its energy intensity. Second, India managed to prevent a further rise in the energy intensity of the industrial sector despite an increase in its share of total energy use. Third, the energy intensity of -158- power generation increased only marginally. The following sectoral factors contributed to change in the energy intensity during 1973-82. 54. While the energy intensity in the industrial sector has remained virtually unchanged since the early 1970s, mainly because of the slow turn- over of capital, it remains high in absolute terms. 1/ A major factor that contributed to the high energy intensity of India's industrial sector was the relatively poor energy efficiency of the technology employed in many manufac- turing processes. Considering that energy prices and in particular petroleum prices had declined considerably in real terms, it is understandable that energy costs played only a minor role in the choice of technology. Up to 1973, almost all of India's steel plants used the open-hearth process which needs considerably more energy than basic oxygen furnace or electric arc technologies. Similarly almost all cement plants in India used the wet process which is more energy-intensive than the dry process. And in the fertilizer industry an increasing share of the plants were based on petrochemical feedstocks using oil products, mainly fuel oil as a source of heat. 55. The more widespread use of electric pumpsets and to a lesser extent of tractors and diesel driven pumps accounts for the rather steep increase in the intensity of energy use in the agricultural sector. This is also reflected in the growing share of electric power used in agriculture (Table V.12). 56. The overall energy-intensity in the transport sector declined by about one-third, despite a substantial increase in passenger and freight mileage and a shift from rail transport to trucks and other modes of transport. This reflects not only the higher tariffs for road transport compared to those for rail transport, but also the phasing out of the highly fuel inefficient steam locomotives. 57. Changes in the Demand for Energy. Table V.12 provides an overview of changes in energy supply and consumption in key sectors. It shows that the relative shares of these sectors have not changed significantly, except for thermal power generation and the residential sector. The increase in the share of the power sector reflects the growing emphasis on coal-based thermal power generation. Despite the overall increase in the share of enelgy demand, the power sector did succeed in reducing its share in the consumption of oil products from 14% in 1973 to 10% in 1982. Coal use increased during the same period from 85% to 89%. Thermal power generation made the largest contribution to the reduction of oil demand. Except for agriculture, whose 1/ In terms of industrial energy intensity, India ranked in 1973 near the top among developing countries and well above the average intensity in industrial countries. -159- overall share in energy demand is small, all other sectors either maintained or increased their share in the consumption of oil products. Table V.12: ENERCY BALANCES FOR 1972,1978 AND 1982 1972 1978 1982 (Mill. toe) M%) (Mill. toe) T%) (Mill. toe) (%) Indigenous Production 114.1 87.8 149.6 89.9 178.4 92.8 Oil 7.5 5.8 11.9 7.2 21.6 11.2 Gas 0.5 0.4 1.2 0.7 1.9 1.0 Coal 38.5 29.6 51.7 31.1 63.3 32.9 Non-commercial fuels 58.9 45.3 69.5 41.8 76.1 39.6 Primary Electricity 8.7 6.7 15.3 9.2 15.4 8.0 Energy Requirements 129.9 100.0 166.4 100.0 192.2 100.0 Energy Tranuf. & Losses 19.5 15.0 33.1 19.9 42.8 22.3 Fuel Consumption 110.4 85.0 133.3 80.1 149.4 77.7 Industry 27.5 21.2 36.9 22.2 40.7 21.2 Transportation 15.0 11.5 17.0 10.2 19.7 10.2 Agriculture 1.4 1.1 1.9 1.1 2.5 1.3 Residential Sector 63.7 49.0 74.0 44.5 82.6 43.0 Other Sectors 2.8 2.2 3.5 2.1 3.9 2.0 Memo Items Oil Imports 15.3 11.8 18.7 11.2 17.2 9.0 Source: Energy Balances of Developing Countries, International Energy Agency, Paris 1984. 58. Thus, despite efforts to reduce overall energy consumption and to encourage a shift away from oil to other fuels, consumption of petroleum proyucts has continued to rise rapidly. The main reason was the steep increase in the demand for middle distillates. While the overall demand for cil products increased by elightly more than 60% between 1972/73 and 1983/84, the demand for middle distillates has increased by about 90%, mainly because of the Government's reluctance to raise their relative price. E. Energy Issues for the Future 59. All areas of energy production and demand management present major challenges to India's policy makers as they look towards the future. Two areas may be highlighted here because of their exceptional importance-- fuelwood and petroleum. -160- 60. Crowing Fuetwood Deficit. Roughly 40% of total energy consumption in India is accounted for by non-commercial fuels. The bulk of these non- commercial Euels consists of fuelwood. Only about one-third consists of vegetable wastes and cow dung. Numezous surveys and reports have pointed out that India is not only a fuelwpod deficit country, but that this deficit is growing at an alarming rate. And it is argued that the two oil price shocks and the dubsequent increases in domestic fuel prices have contributed to this dbficit, particularly in rural areas. 61. Average per capita fuelwood consumption is estimated at 150-170 kg. per annum. For the country as a whole thia would amount to about 120 million tons of fuelwood, roughly equivalent to 60 million tons of oil. There is a distinct difference in the kind of fuelwood that is consumed in rural and urban areas. In rural areas fuelwood consumption consists mainly of twigs and in urban areas mainly of logs. Unlike twigs, it is quite economic to transport logs over long distances. Thus logs have become an increasingly important 'commercial' fuel in India. In urban markets fuelwood competes with kerosene, LPG and electricity as a fuel for cooking. Fuelwood remainR still the main fuel for cooking in rural areas. Kerosene is mainly used for lighting; electricity is available in only about half of India's villages, and there is virtually no distribution of LPG outside the larger cities. But even if reliable supplies of electricity and LPG would be available, the comparatively low cost of fuelwood and generally lower incomes in rural areas are likely to limit switching to commercial fuels. Thus urban areas offer the greatest potential for replacing fue'wood with kerosene, LPG or electricity. Almost all projections of fuetwood consumption assume that this potential will be realized to some extent in the years ahead and show there- fore a slowing down in the growth rate. Nevertheless, only a projection prepared by the Working Croup on Energy Policy in 1979 expccts an absolute decline in fuelwood consumption, all other projections including one prepared by the Bank see a ftrther increase in fuelwood consumption, albeit at a slower rate. Thus the pressure on fuelwood supplies is likely to grow in the years ahead. 62. India's forests are estimated to yield about 50-60 million tons of fuelwood annually on a sustainable basis, equivalent to about half of fuel- wood consumption. The remaining half comes from trees on farms, along roads, etc., and froir a reduction of the forest area. Since 1951/52 almost 14Z of the total forest area has been cleared for a variety of reasons. The result has been a gradual reduction in sustainable yields. 63. The growing fuetwood deficit has not only accelerated the process of deforestation; it has also adversely affected rural welfare. First, as more and more time has to be used for collecting fuelwood, less time is available for 'productive' work. Second, the growing scarcity leads to a greater use of cowdung and vegetable wastes, which reduce the availability of manure to increase crop productivity. -161- 64. The Government has essentially two policy options: (a) increAse fuelwood supplies through social forestry products; and (b) reduce fuelwood consumption by encouraging the use of substitutes and the more widespread use of energy efficient stoves. Low incomes in rural areas severely con- strairn the replacing of fuelwood with commercial fuels (kerosene, electricity). In addition, experience with the use of more fuel efficient stoves has not been encouraging. While efforts in these areas should not be abandoned, the Government will need to accelerate the expansion of social forestry programs to prevent a further worsening of the fuelwood deficit. Prospects for Oil Imports in the 1990s 65. Demand Prospects. Despite the continued growth in domestic oil demand. India has succeeded in reducing its dependence on imported oil since the fist oil price shock. While in 1973/74 less than one-third of domestic oil demand was met from indigenous production, this share increased to more than two-thirds by 1983/84. Whether the dependence on oil imports will continue to diminish in the years ahead depends on the success of ONCC's and OIL's exploration efforts, the time required for the development of any discoveries, and the extent to which the growth in oil product demand can be contained. 66. Table V.13 summarizes the projections for oil and oil product imports based on the assumptions about the growth of key economic sectors used in the main text of the report (Chapter 3). 67. Potential for Increasing Oil Production. Oil production can be increased in the short term by raising output levels to the technically feasible limits of each field, or where indicated, by applying enhanced recovery techniques. In the long term, further increases in indigenous oil production clearly depend on the discovery of new fields. At present India's reserves-to-production ratio is 20 years. ONGC's production policy is based on a minimum reserves-to-production ratio of 15 years. As production from existing offshore fields reach their technically feasible level, total domes- tic oil production would peak at about 35-37 million tons during the later part of the 1980s unless new discoveries are made that would allow ONGC to maintain its minimum reserves-to-production ratio. In line with the assump- tions made for the Seventh Plan, it was assumed here that the discovery of new fields would progress at a rate that would permit an annual increase in domestic oil production of between 2-3 million tons. -162- Table V.13: PRODUCTION, DEMAND AND UET IMPORTS OF CRUDE OIL AND PETROLEUM PRODUCTS, 1980/81 - 1989/90 (million tons) Crude Oil Refinery Products Net Through- Net Con- Production Imports Supply put Production Imports sumption 1980/81 10.51 16.25 26.76 25.84 24.12 7.25 30.90 1981182 16.19 14.46 30.65 30.15 28.12 4.83 32.52 1982/83 21.06 12.60 33.66 33.16 31.07 4.23 34.66 1983/84 26.02 10.98 37.00 35.26 32.89 2.72 35.84 1984/85 (R.E.) 29.00 7.10 36.10 35.6 33.2 6.4 38.44 1985/86 (B.E.) 30.14 13.2 43.30 42.10 39.30 2.3 40.77 1986/87 31.40 12.90 44.30 43.25 40.30 4.50 44.80 1987/88 32.30 14.60 46.90 44.33 41.30 6.3 47.60 1988/89 33.75 13.95 47.70 45.00 41.90 9.20 50.70 1989/90 35.30 14.10 49.40 47.94 44.70 9.20 53.90 R.E. = Revised estimate. B.E. = Budget estimate. Source: GOI. 68. Potential for Reducing Oil Consumption. Kerosene and diesol oil consumptioD account together for more than half of domestic oil consumption. Considering also their large share in oil product imports, these two products clearly offer the greatest potential for a reduction in oil consumption. It has been pointed out in the discussion on the fuelwood deficit that the urban sector offers the greatest potential for replacing kerosene with LPG and electricity. Thus, utilization of India's relatively large gas reserves for extraction of LPG, and power generation, could result in a substantial reduc- tion in the demand for kerosene. As far as diesel oil is concerned, the increase in its consumption is largely a result of the expansion of road transport, the more extensive use of diesel pumpsets for irrigation and growth of captive power supply units. Again, the increased and more reliable availability of electricity and the availability of gas (particularly for industrial uses) offer the greatesc potential for containing the growth of demand for diesel oil. 69. Thus, in the medium-term intensification of exploration efforts for both oil and gas, continued eiforts to contain the growth in the demand for middle distillates through pricing policies and other conservation measures, and a more extensive use of domestic gas resources are the major options for reducing oil imports. -163- WORKING PAPER VI KANUFACTURING INDUSTRY, EXTERNAL ADJUSTMENT AND STRUCTURAL CHANGE - 1973-83 Prepared by Roger W. Grave -164- WORKING PAPER VI MANUFACTURING INDUSTRY, EXTERNAL ADJUSTMENT AND STRUCTURAL CHANCE - 1973-83 Page No. A. introduction - Indicators of Change....e.e................ 165 Growth............ ........ .. .......... . 165 Productivity ................................................ 167 Import Substitution .............. .......................... 169 Role of Public Sector......................................... 170 B. Infrastructure and Import Requirements........................ 171 C. Energy Conservation in Selected Manufacturing Industries...... 176 D. Structural Adjustment and Longer Term Trade and Industry Policy ................................... 177 Import Utilization and Export Performance..................... 177 Exchange Rates and Tai. .................. ..... 183 Costs of Raw Materials........................................ 184 E. The Impact of Domestic Industrial Policies on Costs........... 187 Attachment I: The Indian Tariff System: Some Problems and Consequences................... 189 Introduction..o.... 4.O.... 000.............. 0................. 189 The Level of Tariffs........ ........ . .................. .90 The Structure of Tariffs ......... ........................ 193 Some Problems ........ ............................... 195 Future Directions........................................... 197 Attachment II ........ .................................. 198 Tables VI.1 The Growth of Manufacturing Production - by Use and Input Base.... ........ ..... . .............. ..... 167 VI.2 Sumary Findings on Total Factor Productivity......o........ 168 VI.3 Changes in Total Factor Productivity...........*....o....... 169 VI.4 Relative Shares of the Public Sector in Manufacturing....... 170 VI.5 Production Performance Indicators in Major Industries....... 173 VI.6 Comparison of Actual and Estimated Energy Consumption for Selected Industries.........o...o......... 179 VI.7 Import Content in Raw Material Inputs....................... 180 VI.8 Import Content of Raw Material Purchases by Exporting Firms............................. ........ 184 VI.9 Index of Relative Prices.................................... 186 -165- WORKING PAPER VI 1/ MANUFACTURING INDUSTRY, EXTERNAL ADJUSTHMENT AND STRUCTURAL CHANGE - 1973-83 A. Introduction - Indicators of Change 1. Over a period as long as a decade external adjustment inevitably merges with the longer term issues of structural change. This is of course entirely appropriate: successful structural adjustment should result in an economy or sector better able to withstand short-term shocks without sacrificing longer term development objectives. For Indian industry these objectives--accelerated growth and improved productivity-remain as challeng- ing today as they were at the beginning of the 1973-83 decade. 2. Growth. The Wcrld Bank in its 1974 Report described the situation facing India as follows: '... the impetus for accelerated and sustained growth has to come from an industrial sector which grows more rapidly than the rest of the economy. Unfortunately for nearly a decade, instead of being a dynamic growth sector, industry has been plodding along roughly at the same pace as the rest of the economy. India is currently caught up in economic difficulties which threaten to further obstruct industrial growth. To rever3e the trend of industrial stagnation in the face of mounting difficulties is one of the hardest tasks facing policy makers during the Fifth Plan." In succeeding 10 years India has managed well two adjustments to severe external shocks and indeed enjoyed an interim period (1977-79) of unan- ticipated resource surplus. But India' growth performance, though undoub- tedly improved, still shows too little evidence of the structural transforma- tion that would result in industry' playing a leading role. The challenge facing India at the onset of the Seventh Plan is little different than the task cited above for policy makers during the Fifth Plan. During the decade 1973-83 India's GDP grew at 3.8% per annum while manufacturing grew barely faster at 4.2% per annum increasing its share to only 15.6% from 15.2% at the beginning of the decade. Nor has manufacturing brought stability to the growth process: the variability of growth in manufacturing being hardly less than 11 This Working Paper, together with six others, supports the analysis in Chapter 2 of the Report, India: Structural Change and Development Perspectives, Report No. 5593-IN, dated April 24, 1985. -166- that for GDP growth. 1/ GDP growth continues to be dominated by agriculture both directly through agriculture's substantial share in CDP and indirectly throixgh the continuing importance of supply and demand linkages ;ith industry. 3. The sectoral composition of industrial growch in India provides further indication of structural characteristics of Indian industry. A comparison of growth rates disaggregated accordiag to the use based class- ification (Table VI.1) indicates little change in the relative growth perfor- mance of various sectors between the period preceding 1973 and the following decade while confirming the broad-based decline in growth. Basic industries, which constitute the core of the public investment program in industry, grew at 7.1% per annum during both periods. Capital goods, which had grown at 8.3% per annum during the earlier period, decelerated to only 4.3% per annum after 1973. Intermediate goods (e.g. jute manufactures, cotton spinning, automotive parts, petroleum products) also decelerated, but from the already slow rate of 4.3% per annum to 3.0%. The growth of c:isumer goods industries changed little between the two periods, but within this category there was a significant deceleration in growth of durable goods from 8.3% per annum (starting from a very low base) between 1960 and 1973 to only 4.5% from 1973 to 1982 while non-durable consumer goods actually accelerated from 3% per annum (barely above the rate of population growth during 1960-73) to 4.1% per annum after 1973. 4. The modest improvement in consumer goods performance is reflected in the similarly tentative acceleration of agro-based goods from 2.5% per annum to 3.0% while metal-based and chemical-based goods decelerated significantly. The etiology of the slowdown in industrial growth in India during the 1970s has been extensively discussed elsewhere. A summary of that analysis points to: "four factors which contributed to industrial stagnation. These were (W) slow growth of agricultural incomes and their effect in limiting the demand for industrial goods; (b) the slowdown in public investment after the mid-sixties with its particular impact on infrastructural investment; (c) poor management of the infrastructure sectors, leading to severe 1/ The link to agricultural growth has been stressed by K.N. Raj who compared three year moving averages of agricultural growth and lagged industrial growth, concluding that "there have been severe declines in agricultural output at intervals of 7-8 years followed by even more impressive increases and that the industrial output series has moved in similar cyclical fashion with a time lag of 1-2 years". (K.N. Raj, "Some Observations on Economic Growth in India over the Period 1952/53 to 1982/83", Working Paper 198, Center for Development Studies, Trivandrum, 1984). This pattern prevails over the entire post-1950 era. -167- Table VI.1: THE GROWTH OF MANUF&CTURING PRODUCTION - BY USE AND INPUT BASE (Z per annum) Weights 1960-73 1973-82 Use Based Basic Industries 32.3 7.1 7.1 Capital Goods 15.7 8.2 4.3 Intermediates 21.0 4.7 3.0 Consumer Goodo 31.0 4.0 4.2 Durables (2.9) 8.3 4.5 Non-durables (28.1) 3.0 4.1 General Index 100.0 5.6 4.9 Input Based Agro-based 33.7 2.5 3.0 Metal-based 21.9 8.3 4.1 Chemical-based 12.9 9.0 6.1 Source: Statistical Appendix Table 8.2. infrastructural constraints, and (d) the industrial policy framework includ- ing both domestic industrial policies and trade policies and their effcct in creating a high cost industrial structure in the economy." 1/, 5. Productivity. One of the disturbing consequences of this combination of factors has been an apparent decline in the efficiency of resource use within the manufacturing sector. Capital-output ratios have risen sig- nificantly in all major manufacturing categories since 1960. 2? It is this across the board increase which accounts for the rising aggregate capital intensity of Indian industry rather than any shift in relativc importance to the more capital-intensive sectors. At the same time, it was the rising ICORs in the public sector (which accounted for a major share of industrial investments) that contributed to the overall increase in capital intensity. In spite of the rather slow growth of employment in organized sector manufac- 1/ Isher Judge Ahluvalia, Industrial Growth in India - Stagnation Since the mid-Sixties. Oxford University Press, New Delhi, 1984. The time periods used by Ahluvalia are different - 1956/57-1965/66 and 1966/67-1979/8C. The period 1960-73 encorpasses years of more rapid growth from 1960-65 and a slow growth period from 1966-73. Our concerv here is not with deceleration per.se but with the long-term trends that have shaped the industrial context for structural adjustment during the 1973-83 decade. 2/ There has, however, been a temporary decline in ICORs in the late seventies, as documented in the Main Report, Chapter 2. -168- turing of 2.9% per annum this increasing capital intentity has been associated with growth in labor productivity of only 2.5Z per annum. 6. Underlying these trends would seem to be a decline or, at best, stagnation in total factor productivity in the manufacturing sector. 1/ Several recent studies summarized in Table VI.2 which differ somewhat in data bases, methodology, and time periods suggest this: Table VI.2: SUMMARY FINDINGS ON TOTAL FACTOR PRODUCTIVITY Factor Productivity Time Growth Stud Period Sector (Z p.a.) Bhramananda 1960-70 Registered Manufacturing 0.1 1970-80 -1.5 Coldar 1959-65 Large-Scale Registered 1.3 Manufacturing 1965-78 1.9 Ahluwalia 1959-65 Registered Manufacturing -0.1 1966-79 -0.6 Source: Ah1uwalia, op.cit. Chapter 7. It is striking to note that low efficiency characterized even the earlier periods of more rapid growth and to contrast the results for large-scale manufacturing which show a positive trend and an improvement between periods with the results for all registered manufacturing which are negative and declining. 7. A disaggregation by major manufacturing categories (Table VI.3) indicates that the relatively few industries which improved between periods, improved insufficiently to achieve positive productivity growth while several of the industries which had positive productivity growth in the earlier period had negative or zero growth in the second period. 8. Two other structural characteristics of Indian industry which have certainly limited the contribution of manufacturing to structural adjustment 1/ Total factor productivity is simply a measure of the difference between growth in value-added and the weighted growth of all factor inputs. Several rather restrictive assumptions are required to operationalize this concept which do not invalidate results but do require caution in their interpretation. -169- Table VI.3: INDIA: CHANCES IN TOTAL FACTOR PRODUCTIVITY TFPG in First Change Between Periods Period, 1959-65 Decrease No Change Increase Negative Fnod, Beverages, Metal Products Wood (-), Rubber (-), Chemicals, Petroleum (0), Non- Leather electrical Machinery (-), Electrical Machinery (0), Miscellaneous (-) Positive Tobacco (-), Textiles, Furniture Paper (0), Footwear Printing (0), Non-metallic Minerals (-), Basic Metals (-), Transport Equipment (0) Note: Parenthetical notations indicate whether the second period average remained negative (-) or was close to zero (0). Source: Derived from Ahluwalia, op.cit. were the continuing emphasis on (i) indiscriminate import substitution policies though the scope for any generalized reduction of imports had been largely exhausted by the 1970s, and (ii) the channeling of sizeable invest- ment resources into the public sector with as yet incommensurate growth in public sector value-added. 9. Import Substitution. In Ahluwalia's study of industrial deceleration during the 1970s no significant correlation was found between the course of import substitution and growth in manufacturing industries. In many industries import substitution as achieved at a high cost level necessitating continuing controls and/or high tariffs. During the 1970s the major continu- ing area of import substitution were capital goods with a fall in the import availability ratir from over 30% to barely 20% and consumer durables where the decline was even more marked (about 25% to 12%). Both these categories were characterized by significant growth deceleration further underscoring the weakness of import substitution as a source of demand. While import availabilities in non-durable consumer goods and basic industries remained unchanged (at around 5% and 23% respectively), the import availability of intermediate goods increased substantially from little more than 10% at the beginning of the 1970s to about 25% by 1980. As the basic parameters of the import control system have remained relatively stable since 1980, these trends have probably continued in the 1980s. -170- 10. Role of Public Sector. The key role of the public sector in India was mandated as early as 1948 and spelled out in some detail in the Industrial Policy Resolution of 1956 which specified three categories: (a) "core" industries in which all future capacity growth would be in the public sector; 1/ (b) another group of priority industries in which private investment would be allowed on merits though the public sector would be expected to take the lead; 2/ and (c) other industries open to both the private and public sector. By 1970/71 the public sector was responsible for a significant share of manufacturing output and a substantially larger share of investment (Table VI.). However, due to a preponderance of loss-making units in the public sector, savings of non-departmental Government manufac- turing units have been consistently negative. During the 1970s, the mag- nitude of these negative savings increased relative to private coporate savings in spite of substantial. growth in the latter. While both the private and public manufacturing sectors depend substantially on transfers of savings from the household sector and that dependeuce increased for both during the 1970s, both the size of the dependence and is deterioration were much more pronounced for public sector manufacturing. Table VI.4: RELATIVE SHARES OF THE PUBLIC SECTOR IN MANUFACTURING a/ Net Value Added GDCF Savings b/ Employment c/ 1970/171 19.3 30.7 -19.9 16.9 1980/81 21.5 48.5 -88.3 24.1 a Factory sector only. b/ Refers to the share of Government non-departmental non-financial enterprise savings (which have been negative throughout the period) to the algebraic total of those plus savings of the non-financial private corporate sector. c/ Derived from employment data collected by Ministry of Labor. Source: CSO, National Accounts; GDI Economic Survey. 11 These included iron and steel, petroleum (including selected petro- chemicals), heavy industrial machinery, shipbuilding, telecommunications, power generation including atomic energy, air and rail transport. The Government retains the authority to allow private sector capacity to be created in these sectors in the national interest. 2/ These included non-ferrous metals, newsprint, electronics and agricul- tural inputs, and most importantly, fertilizers. -171- 11. There are many aspects to public sector involvement in industry which cannot be fully treated here but should be recognized as influencing the scope and efficiency of public sector industrial activity. While the public sector has been built up mostly through new investment, involvement in some sectors (particularly those in category (c) above) has resulted from Government takeovers of "sick" firms ostensibly to prevent closure and preserve employment. Public sector investment is one means by which Government attempts to achieve industrial dispersion and thereby promote development in "backward areas". Public sector investment is often justified in terms of developing indigenous technical capacities even if commercial considerations would suggest less or delayed involvement. Salary scales and staffing practices in public enterprises are often not geared to effective management. For these and other reasons public sector enterprises are less likely to reach their potential technical productivity, even when public sector projects have been initially justified on scale or technology grounds. These factors combined in many instances with administered prices for public sector output which have often been held below costs to help meet Government inflation targets have also resulted in poor financial performance. 12. The key characteristics of Indian industry - slow and uneven growth, relative priority to basic and capital goods, low and declining productivity, an emphasis on import substitution, and a prominent position for the public sector - have both provided an agenda of long term objectives for Indian industry and constrained the options for achieving those objectives. Against this background the demands of external adjustment have not only increa3ed the urgency of tackling these objectives but have also provided direction to the necessary programs and policies. The need for mere rapid growth in both production and capacity has been particularly focused on key import sub- stituting industries such as fertilizers, iron and steel, aluminum, and cement; the need to improve productivity has focused on energy production and use; the need to achieve greater productivity through a more outward orienta- tion has directed attention particularly to export performance; and the need to improve public sector performance has focused particularly on improving the savings performance of the public sector. The subsequent sections of this Working Paper will deal with (i) the impact of infrastructure con- straints on external adjustment in key industries; (ii) indirect evidence of energy conservation in industry; (iii) longer term effects of trade and industry policies on the contribution of manufacturing to growth and struc- tural change and (iv) the impact of domestic industrial policies on costs. B. Infrastructure and Import Requirements 13. A consequence of the external and domestic shocks for India has been the emergence of severe, mutually reinforcing constraints in power, coal, and transport which set back the production of critical industries such as steel, fertilizers, cement, and aluminium. As a result, the external adjustment to the oil price shocks was compounded by the need to step up imports of these commodities to compensate for shortfalls in domestic production. In several instances prices of these commodities too were increasing rapidly thereby -172- further exacerbating the terms of trade deterioration. In the ensuing adjustment periods improved infrastructure performance with its favorable impact on imports became a matter of high priority. India has been in a position to compress imports of key intermediates through improved perfor- mance of the respective domestic industries. In 1973-76 this was true of iron and steel and fertilizers; in 1979-82, to these commodities could be added cement and aluminum. While the measures required to improve capacity utilization varied from industry to industry and have been discussed in detail in earlier reports, achievements were mixed (Table VI.5). In the first period improvement in steel was evident by 1975, with particularly striking improvements in capacity utilization in 1976 that were maintained until 1979. Capacity utilization in nitrogen fertilizers also improved between 1974 and 1976 contemporaneously with an increase in licensed capacity of almost 50Z. Phosphatic fertilizer capacity almost doubled during this same two year period but production failed to keep pace leading to a rather sharp decline in effective capacity utilization. Aluminium and cement did not figure in imports during this period and capacity utilization fluctuated without discernible trend. After a spurt in 1974/75 steel imports fell steadily through 1976/77, reflecting primarily improved utilization of capacity. Indeed in the 1976-78 period, India became a significant steel exporter as domestic industrial growth was insufficient to absorb increased domestic output. In the case of fertilizers, imports grew markedly between 1974 and 1976 and stabilized at somewhat lower levels in the 1976-78 period. One perspective on import growth in relation to external shocks can e obtained by adjusting imports for shortfalls from potential production (i.e. production based on best to-date capacity utilization). The ratio of adjusted imports to total imports (Table VI.5) then provide an indication of the extent to which imports substitute for poor domestic performance (the lower the r&tio the greater such substitution). Steel showed marked improve- ment from 1973/74 to 1974/75 as the gap between potential and actual produc- tion was eliminated not to re-emerge until 1977/78. The ratio of adjusted to total imports also improved markedly for nitrogenoun fertilizers between 1973-75 and 1975-79, as the relative importance of compensatory imports declined. Phosphatic imports fluctuated markedly between 1972/73 and 1978/79 reflecting both production shortfalls and uneven domestic demand growth. o0..ds e omn *neoteo..=. 0-nnma eea ..... 00ça a:: :0. * *- 0 - - --0 - - -- -- - - s i: .r.::.. 9 i - ti- - - - s't-' - ami B I -174- 14. The second adjustment period presents r different picture. By 1978/79 a combination of domestic demand recovery and foreign exchange availability had resulted in relatively hi6h levels of imports, not only for steel and fertilizers but also for cement and aluminum. Domestic performance was generally strong in 1978/79 with effective capacity utilization at high levels (with the exception of aluminum); consequently the adjusted to total import ratio was also high. The combination of external and internal shocks resulted in the following year in the near stagnation of electric power generation and coal production and severe shortages of transport services and key inputs, particularly diesel and naphtha. This led to a sharp deteriora- tion in capacity utilization in each of these industries. In spite of sig- nificant increases in imports, the ratio of adjusted to total imports fell markedly for each commodity and in the cases of steel and nitrogenous fertilizers, continued to fall in 1980/81. This implies that the 1979/80 shock led on the one hand to a substantial increase in imports to compensate for domestic shortfall and, on the other hand, not lower availability of key commodities as imporLs beyond the compensatory level were cut back. The impact of these import constraints on the economy is difficult to gauge, but their contribution to the relative slowness of recovery during 1980/81 is certainly plausible. 15. The 1981-83 period represented significant improvements in perfor- mance in each of these industries although individual circumstances and indicators varied. Improved capacity utilization relating back to improved infrastructure was the single common factor. In steel this lead to a sig- nificant increase in "adjusted" imports reflecting changes in policy which placed many steel items on OGL and in general increased the range of avail- able imports which supplemented rather than replaced domestic production so that, in the case of steel, resumption of growth in "adjusted" imports is a positive indicator of adjustment. 16. In the case of fertilizers, the ratio of adjusted to total imports returned to the high levels of the mid-seventies while the actual volume of adjusted imports fell markedly reflecting the significant increases in production and effective capacity that occurred between 1981 and 1983. 1/ The major factor in the reduction of "adjusted" imports is that production growth for nitrogenous fertilizer3 grew nearly twice as fast as consumption (15.5% versus 6.8% per annum, 1979-83). Although the differential in phos- phatic fertilizers was much narrower (8.8% versus 7.3% per annum), cyclical stock accumulation appears to have led to the marked import decline at '-he end of the period. While successful adjustment has lead to a reduction in "unnecessary" imports and continued growth in capacity is likely to accom- 1/ The spurt in "licensed" capacity came earlier in a single year, 1979/80, and might have been brought into production more rapidly had this not coincided with the general deterioration. The adjustment for effective capacity smoothed out the process. -175- modate moderately accelerated consumption growth, the scope for increased fertilizer use in India remains significant; but rapid consumption growth would inevitably lead to more imports. Furthermore, much of India' fer- tilizer capacity is old and inefficient. Phasing it out expeditiously, in favor of imports, may well save resources for India. Like steel then, the implications of favorable developments in the fertilizer sector could well imply substantial import growth during the next decade. 17. The situation in aluminum and cement presents a somewhat different picture and outlook. In both cases the gap between potential and actual production considerably exceeded imports in spite of strong production growth between 1979 and 1983. In the case of aluminum, imports have fallen largely because of poor demand with major consumers such as SEBs failing to m2intain orders. Large inventories (exceeding 35Z of domestic production held by one public sector unit alone) accumulated between 1977 and 1981. There continues to be substantial scope for improved capacity utilization, which has been generally constrained by inadequate and intermittent power supply. Increased captive power generation has improved the performance will need to be extended. Retention pricing, production and distribution controls may also require modification both to improve capacity utilization and perhaps even more important in the light of the substantial new capacity coming on-stream, to lower costs and increase domestic demand. Thus in the case of aluminum successful adjustment should lead not only to a low level of specialized imports but to India's becoming a major exporter of aluminum products. 18. While capacity utilization in the cement industry improved only marginally between 1979-81 and 1981-83, this occurred in the context of accelerated and substantial growth in both production and capacity. This followed several years of stagnation after the fist adjustment period. Nevertheless & gap remained between potential and actual production that imports failed to cover. As a result of excess and growing domestic demand, a significant black market emerged during this period. Imports of cement were canalized during this period, and prices and distribution were controlled. However the encouraging production response to price increases in 1979 lead to the dual pricing and liberal imports policy announced in February 1982. As a result capacity and production trends have further accelerated to the point where in 1983/84 there have been only nominal cement imports, the black market has disappeared and market clearing prices have come down. Further decontrol ot the industry could lead to India exploiting its apparent comparative advantage in cement with substantial exports. 19. Comparisons between periods and across categories are treacherous; but there are some tentative conclusions which are suggested by the experience of these major industries. First the impact of infrastructure bottlenecks associated with external shocks can be traced through sharp decline in effective capacity utilization to higher imports thus reinforcing the impact of the external shock. In the ensuing adjustment periods clear instances of short-term adjustment which combined improved capacity utilization, rapid production growth, and lower import ratios are apparent -176- for both finished steel and nitrogen fertilizers in the first period and for both nitrogen and phosphatic fertilizers in the second period. The continued high impnrt ratio for finished steel in the accond period reflected both a shortfall in domestic production geowth and a growing structural mismatch between the composition of domearic production and demand. While aluminum di4 not figure in imports during the first adjustment period, there was significant growth in capatcity and production, particularly in 1975-77. As aluminum is a critical input Ior power distribution, this growth supported the increased emphasis on dGmestic power production which otherwise would have required significant aluminum imports. The second period which was characterized by stagnant capacity and slow production growth resulted in falling import ratios only as a consequence of poor offtake. 20. Responsiveness in the cement industry was focused in both periods on improved production -- largely through increased capacity utilization in 1973-76, and by maintaining production apace with capacity growth during the second period. A key factor in this pattern of adjustment in the cement industry, which is predominantly private sector, was the substantial increase in the controlled price of cement in 1975 and again in 1979 (34% and 27% respectively, f.o.b., exclusive of duty and packing charges). The 1975 adjustment was particularly important in encouraging fuller use of existing capacity and in encouraging the investment in new capacity that came on stream during the second adjustment period. The second price increase encouraged the completion of this new capacity and set the stage for the liberalization package of partial decontrol that took effect toward the end of the second period. 21. Perhaps the main conclusion to be drawn from this of short-term adjustments in key import substituting industries is that, during the second period, issues of industrial strategy and structure had become sufficiently complex that "adjustment" could not be achieved as readily through improved utilization of existing capacity based largely on the relaxation of infractructural constrains. Investment allocation, internal resource generation, the mesh of demand and production structures, and the trade and industrial policy framework had all to be considered in devising a strategy that would meet India's longer term development objectives while facilitating external adjustment requirements. To the extent allowed by short-term balance of payments needs in the second period, the emphesis has clearly been on investment and policy changes which point the direction for improved long-term performance. . Energy Conservation in Selected Manufacturing Industries 22. Another important aspect of adjustment in manufacturing involves the sector's response to the sharp increases in the relative price of energy through energy conservation measures in the short term aad iubstitution of other inputs for energy over the longer term. The scope for both these responses is significant in India. In the 1983 Report on Utilization and Conservation of Energy, an interministerial working group identified numerous -177- measures which could result in substantial energy savings in industry. 1/ There ia also great scope for energy saving technical change given India's abundance of labor, which has been generally found to substitute for energy in the production process, relative to cnpital which in generally complemen- tary to energy use. There is also considerable scope for the introduction of more energy efficient processes in particular industrien which are heavy energy users, such as cement. 23. While a comprehensive assessment of these trends has not been attempted here, a comparison of actual versus estimated energy consumption (Table VI.6) has been made for five industries. Two periods are analyzed: 1974/75 through 1976/77, and 1979/80 through 1981/82. Estimated consumption is based on the technical coefficients of energy input as of 1973/74 adjusted for price increases in subsequent years. This yields an index of estimated energy use without conservation or technical change. Comparing this to an index of actual energy consumption provides a rough indication of how effec- tive conservation and substitution efforts have been. By the end of the first period actual energy use fell short of estimated use in two industries: iron and steel, and machinery. In both these industries this Lrend inten- sified in the later period with the ratio of actual to estimated indices declining to about 70 by 1982 from the 1974/75 base of 106. Of the three other industries for which this calculation was mrade, cement showed the most marked evidence of energy saving during the latter period with the index dipping to 40 by 1981/82. Chemicals and cotton textiles had also improved by the beginning of the second period; but in both cases the ratio of actual to estimated energy use again exceeded 100 by 1981/82. 24. While these calculations must be regarded as tentative, they do suggest, at least in a few industries, that adjustments in energy use have served the objectives of external adjustment. D. Structural Adjustment and Longer Tsrm Trade and Industry Policy 25. Import Utilization and Export Performance. Even after the fist oil price shock Indian policy makers realized that, (aside from the basic industries discussed above), there was little scope for additional general import constraints. First, because imports were already compressed to essen- tial levels in most sectors, further reductions would in the short-term lead only to lower capacity utilization. The volume of mohinery and transport equipment imports in 1973/74 was 12% lower than in 1960/61; of manufactured goods imports, 7% lower; and of crude material imports, 47% lower. Second, the course of general import substitution had been largely run. While pos- sibilities for efficient import substitution would continue to arise, these should be pursued primarily for their contribution to a more modern, effi- 1/ These findings were discussed in Chapter 8 of the World Bank's 1984 economic report on India (Report 4962-IN). -178- cient industrial structure. 1/ This in turn would call for easier access to imported technology, through both foreign collaborations and increased access to imports embodying new technology. Insufficient access to such imports has been identified as a major cause of India's failure to develop a stronger capability for sustaining technological change. 2/ As the pressures for external adjustment grew so did a realization that efficient import substitu- tion would have to be complemented by, and indeed was consistent with, accelerated growth of industrial exports. 26. The need to expand exports in the short-run required an appropriate mix of trade, industrial and macroeconomic policies. During the period preceding the first oil price shock, policy and performance trends had actually lead to a situation in which t'e industrial sector was relatively well-placed to respond to a mix of polit-ies intended, as a main objective, to promote exports. Industrial capacity had grown rapidly during the early 1970s, averaging almost 8% per annum from 1971 through 1974. The real effec- tive exchange rate had gradually depreciated reflecting both the rupee/UK pound link and relatively favorable domestic/internationaL price trends. The international environment was also favorable, first in the unprecedented boom in OECD countries in the early 1970s and after the oil price increase, in the more limited but easily accessible markets for India in West Asia. 27. However, these conditions were not in themselves sufficient for Indian exports to sustain the desired growth. The reletively greater profitability of domestic sales meant that even the capacity growth of ear- Lier years would likely be absorbed in the domestic market unless domestic demand were restrained or relative profitability reduced. Suppression of domestic demand also coincided with the nd to dampen industrial price infla- tion which had accelerated to 20.2 in 1973/74. Between 1973 and 1975 a variety of monetary and fiscal measures were employed to slow the growth of domestic demand. Interest rates were raised and other measures introduced to curb the growth of bank credit both to Government and the private sector. New tax measures were introduced; both plan and non-plan expenditure growth 1/ Ref. to Isher Ahluwalia, op.cit., Chapters five and six. The work of Bhagwati and Desai, and Bhagwati and Srinivasan which documented the impact of trade and industrial policies of the 1960s and early 1970s on industrial efficiency was widely recognized by 1973/74. An exercise decomposing sources of demand in the Indian economy utilizing three comparable input-output tables from 1959/60, 1968/69 and 1973/74 provides strong evidence for decline of import substitution to a negligible source of industrial demand between the latter two years, after having played a major role between 1959/60 and 1968/69. 2/ Studies on development of technological capacity by Sanjaya Lal, Asok Desai and others have documented such gaps for numerous industries. -179- Table VI.6: COMPARISON OF ACTUAL & ESTIMATED ENERGY CONSUMPTION FOR SELECTED INDUSTRIES (1974175 = 100) Item 1975/76 1976/77 1979/80 1980/81 1981/82 Index of Actual Energy Consumption Cement 151.02 170.38 188.20 164.65 197.43 Chemicals 145.29 187.95 261.06 324.86 344.72 Iron & Steel 133.66 165.70 211.57 263.59 - Cotton Textiles 123.29 144.46 213.49 283.83 187.40 Machinery 115.26 140.18 198.09 253.65 239.84 Index of E3timated Energy Consumption Cement 163.00 181.86 242.18 289.90 348.56 Chemicals 132.84 165.75 295.09 330.19 275.96 Iron & Steel 161.87 191.82 295.40 369.47 - Cotton Textiles 125.98 143.82 250.50 307.51 182.61 Machinery 117.42 146.87 245.43 318.06 329.53 Index of Rate of Actual to Estimated Energy Consumption a/ Cement 99.00 99.00 83.00 60.00 60.00 Chemicals 109.00 113.00 88.00 98.00 125.00 Iron & Steel 83.00 87.00 72.00 71.00 - Cotton Textiles 98.00 100.00 85.00 93.00 103.00 Machinery 97.00 94.00 81.00 79.00 72.00 a/ Ratio of actual to estimated energy consumption index in each year converted to in%ex number based on 1974/75 = 100. Source: CSO RBI. -180- was restrained. 1/ One consequence was a significant drop in capacity utilization in thc industrial sector 2/ from an average well above 80% in the early 1970s to only 73% in 1974/75. The combination of slack industrial demand and supportive exchange rate and other trade policies were sufficient to turn many producers, at least temporarily to external markets, so that India was able to sustain, and by some measures, even improve on is strong export performance of 1972/73. The quantum of machinery and transport equip- ment exports more than doubled in 1974 while exports of miscellaneous manufactures (SITC-8) showed consistently high growth averaging 30% per annum in volume terms between 1972-76. 28. To a considerable extent this spurt in export performance was accomplished without significant growth in imported inputs. For example the import content of raw materials consumed by some growing export inaustries in the engineerin- industry declined markedly between 1972/73 and 1974/75 (Table VI.7). lable VI.7: IMPORT CONTENT IN RAW MATERIAL INPUTS (Percent) Finished Product 1972/73 1973/74 1974/75 Hand Tools 29.7 22.7 17.0 Wire Ropes 27.2 15.0 19.6 Textile Machinery 15.1 10.1 10.3 Source: ICICI. Export Performance of Firms, 1974-76. By and large this was due to improved domestic availability of major raw materials, especially steel. Inventories of raw materials, stores and finished goods increased significantly in 1974/75 and again, more modestly in 1975/76. Import volumes of most major categories fell markedly during the 1973-76 period. In addition to improved availability of domestic goods, this general phenomenon was also a result of the slow growth in industrial produc- tion other than basic industries. 1/ A detailed summary of monetary and fiscal policies may be found in Section V of India's Economic Policies, J.L. Mongia, Editor, Allied Publishers, New Delhi, 1984. 2/ SuppLy constraints, particularly poor labor relations in the public sector also played an important role in the sharp decline in capacity utilization in 1974. -181- 29. Following 1976, the requirements of external adjustment had altered dramatically. As discussed in Annex I, India found itself in the paradoxical situation of running current account surpluses. In order to avoid the inap- propriate status of a net capital exporter, India needed to increase its absorption of external resources through increased imports. The dilemma this posed for industrial and trade policy was, irenically, even more difficult than the adjustment to the first oil price shock. The role of imports in the Indian industrial economy had been progressively narrowed so that imports of processed raw materials, manufactured intermediates and capital goods con- sisted of items for which there was judged to be either insufficient demand to justify setting up a plant in India, or for which technology or key raw materials were not available. Expansion of imports other than these "essential" imports threatened the production, either existing or potential, of Indian manufacturing units. The first steps toward liberalization took place as early as 1976/77, but it was only after a more systematic overhaul of policy in 1978/79 that an effective compromise between these concerns emerged. The policy was most liberal with respect to intermediate inputs and raw materials not currently manufactured in India including, in theory, items not previously imported. Items which were manufactured in India but which had previously also been imported were subject to licensing. However, licen- ses not only allowed automatically for growth over past import levels, but coulA also be supplemented if production conditions changed. The most restricted group of imports judged to be directly competing with domestic production were available only to export units on the basis of a replenish- ment system geared to past export performance, but unlike other import licenses, these "replenishment" licenses could be freely transferred. The impact of this system on import growth was significant. Between 1973/74 and 1978/79 the volume of non-oil imports nas grown 16.1 per annum While there have been a few industries adversely affected, these have generally been producers of raw materials competing for short periods with imports tem- porarily available at prices at or below marginal cost in international markets. In cne or two cases India has raised customs duties, but in general the policy has been to allow Indian consumers to benefit from such situations. 1/ Consumer goods and intermediate goods industries reacted well and overall manufacturing began to show signs of recovery as early as 1978. 30. The situation facing Indian industry as a result of the second oil price shock in 1979 was almost overshadowed by that year's widespread drought and accompanying shortfall in agricultural production compounded by power and transport bottlenecks and supply constraints in key industries such as steel. The setback to Indian industry was severe. Manufacturing stagnated in both 1979 and 1980. By 198J the recession was widespread with stagnation or output declines in basic, intermediate, and non-durable consumer goods. The lagged effect of recession hit capital goods and consumer durables in the 1/ A more detailed account of import policy changes and growth was given in the 1983 Economic Report (No. 4395-IN). -182- following year as growth slowed to 3.5% per annum and 1.7% per annum respectively. Capacity utilization which had remained low in the late seventies, averaging barely 75% between 1976-79, slipped again in 1980 to a level not much above that of 1974/75. Under these circumstances the conse- quences of a general reduction in import availability in response to the added trauma of the second oil price shock would have still further delayed in industrial recovery. 31. In the short term, external financing from a variety of sources allowed India to maintain the procedurally simplified import regime that had been formally established only in 1978/79. However the terms on which exter- nal financing became available to India significantly hardened during the initial stages of the second adjustment period. Especially after India's IMF Trust Fund allocation had been exhausted, the most advantageous financing involved the use of foreign exchange reserves supplemented by regular resour- ces from the IMF through the extended arrangement negotiated in 1981. Additional incremental resources were also required but were available only at or near commercial terms (see Chapter 5 for a fuller discussion of trends and options in external financing). Increasingly these will be the main source of financing for Indian external requirements. 32. India's relatively improved performance during the 1970s and her favorable external debt profile had secured India a strong creditworthiness rating which she still enjoys. But the accumulation of more expensive debt must eventually be accompanied by export growth adequate to sustain foreign savings at a substantially higher level of debt service as this more expen- sive debt matures. Indeed accelerated export growth has been recognized as a key component of India's adjustment strategy right from the beginning of the second oil price shock, as documented in the ambitious targets of the Sixth Plan. 1/ Achievements to date have been disappointing. The volume growth of manufactures exports at 2.8% per annum between 1979 and 1983 has lagged behind even the slow growth - 3.1% per annum - of manufactures output during the same period. 33. This performance is doubly disappointing given widespread recognition of both the need to improve performance and of the impediments to more rapid export growth in the past. 2/ While the sluggish world economy and the associated revival of protectionist measures undoubtedly affected export performance, the response in many countries was to implement a combination of 1/ The Sixth Plan was of cc-rse formulated before the impact of the second oil price shock and OECD economic policies on world trade was felt. It also assumed the continuation of appropriate trade policies such as had facilitated India's improved performance in the 1970s. 2/ See for example, The Tandon Committee Report (1980), and the Economic Survey, various issues. -183- trade and industrial measures geared to incrcase productivity and reduce costs. While the need for a c*mprehensive approach is generally acknowledged in India and elcents of an appropriate mix of policies have been put in place in recent years, neither the extent nor breadth of policy change appears to have reached the critical threshold. 34. Exchange Rates and Tariffs. Real effective exchange rates are dis- cussed in Working Paper II.I; but it is appropriate to emphasize here that the same trends which apply to the aggregate real effective exchange rate index (REER) are accentuated in the case of manufactures, where the REER deteriorated between 1979 and 1981 as the nominal effective exchange rate failed to compensate for adverse relative price movements. The REER has remained rather steady since mid-1980, certainly an achievement during a period of significant fluctuations in exchange rate among India's major trading partners. But this, in combination with relative stability in other incentives to manufactured exports, has not contributed sufficiently to an environment geared to more rapid export growth. While internal supply fac- tors and external demand have clearly influenced export performance, numerous indications point to a significant role for relative international price competitiveness in encouraging a wide range of exports, particularly of products which are less capital intensive and less dependent on infrastructure, backward linkages and imported inputs. These tend to be products of natural comparative advantage for India which should form the core of India's export effort. Examples from the 1970s which responded strongly to relative price competitiveness include castings and forgings, other metal products, non-metal mineral products, ready-made garments, print- ing and publishing, handicrafts, gems and jewelry. 11 35. Other aspects of che trade policy system have undoubtedly also affected relative costs ard the competitiveness of Indian manufactures; but their impact is difficult to measure and indeed may have been in offsetting directions. The general relaxation of quantitative restrictions on imported inputs and capital goods including spares can be presumed to have improved the efficiency of factor use by widening the choice of inputs. Little direct evidence of this effect is available but data collected by ICICI from a sample of over 250 exporting companies (Table VI.8) do suggest increased import intensity in export production. 36. Imported inputs can lower costs in two major ways: (a) directly, by virtue of their lower cost relative to domestic substitutes; and (b) indirectly, by their greater technical productivity in the production process. Both of these can be thwarted if tariff levels are set at high levels. Preliminary analysis of the strvzture of tariffs in India raises this as a real possibility (see Attachment 1 to zhis Annex), although as 1/ See also "Situation and Prospects of the Indian Economy - A Medium Term Perspective," No. 4962-IN, 1984, Chapter 3. -184- Table VI.8: IMPORT CONTENT OF RAW MATERIAL PURCHASES BY EXPORTING FIRMS (Percentages) Industry Croup 1976/77 1977/78 1978/79 1979/80 1980/81 1981/82 1982/83 Auto and Products 18.2 16.5 16.2 17.1 18.2 17.7 Cement 1.3 1.6 0.8 0.8 2.1 4.8 15.6 Chemicals 13.0 17.4 20.6 21.0 26.4 30.3 29.4 Electrical Equipment 19.4 21.3 16.7 17.5 23.4 25.1 24.3 Food Products 4.3 20.6 0.4 0.8 0.7 1.1 1.4 Glass and Pottery 10.0 8.6 32.5 8.7 9.7 15.1 7.0 Machinery 31.8 23.7 19.7 19.3 23.9 22.5 24.0 Ferrous Metals 20.8 8.9 28.4 9.2 19.8 11.5 4.3 Non-ferrous Metals 13.9 14.8 9.3 29.5 33.4 29.0 16.6 Pulp/Paper 3.8 5.4 5.2 6.4 8.8 8.9 14.1 Rubber Products 4.6 6.1 1.6 7.9 11.3 13.5 16.3 Cotton Textiles 6.6 18.0 18.3 17.0 18.6 16.4 15.9 Diversified - - - 19.5 21.3 13.3 15.6 Miscellaneous 7.1 7.7 10.6 15.8 12.1 12.8 11.6 Total 13.5 15.4 16.0 16.2 19.2 17.7 18.7 Note: Sample size, and coverage of firms vary somewhat from year to year, so that annual changes must be interpreted with caution. Source: ICICI, Financial Performance of Companies, various issues. noted there, it is difficult to generalize about the incidence of tariffs owing to the large number of special reductions and exemptions. 37. Indeed, it is possible that the relaxation of quantitative restric- tions may have actually increased the distortions and cost base in the indstrial sector by facilitating economically inefficient activities which are financially profitable as long as import of the final product (e.g. consumer durables or other consumer goods) remain banned. Even without this effect it seems probable that the course of the real effective exchange rate since 1979/80 has significantly discouraged exports while the high levels of and further increases in many tariffs may have limited the positive impulse which the relaxation of some quantitative restrictions would otherwise give to exports. 38. Costs of Raw Materials. In spite of the increased availability of imported inputs, and their increased role in the cost structure of Indian industry, India's broad resource base and large domestic market has resulted in the domestic production of most key industrial raw materials. In many cases these commodities have been subject to various forms of price controls, either direct in the case of private sector output or indirect through the administered prices of public sector units. Since 1979, there have been -185- changes in pricing policy for many of these commodities. 1/ (These changes are summarized in Attachment 2). In some cases - notably steel - the price setting mechanism itself has been significantly altered so as to remove the direct role of Government. 2/ In other cases controlled prices have been more directly linked to costs in an effort to reduce public sector deficits. While these developments are certainly welcome in terms of reducing the direct Government subsidy, cost-plus pricing simply passes the subsidy burden on to consumers in the form of higher costs without providing any incentive to improve efficiency. The resulting high costs of production of important raw materials have resulted in a paradoxical situation during the post-1979 period: international commodity markets have been abnormally soft while Indian price decontrol led to rising domestic prices. Between 1973/74 and 1978/79 a weighted ratio of international to Indian prices for 12 major industrial inputs increased by more than 32%. In general relative price movements were especially favorable in steel and chemicals and less so for non-ferrous metals, newsprint and rubber (Table VI.9). However, in the subsequent period, 1978/79-1983/84, relative prices of all twelve commodities, except aluminum, deteriorated markedly. This was especially true between 1980/81 and 1982/83 when the weighted index, led by steel, dropped by almost 30%. Of course in an open economy the impact of such rice differentials on export costs can be mitigated by either exchange rate move- ments lowering the foreign exchange prices of exports or by a higher propor- tion of imported (lower cost) inputs for export production. The nominal effective exchange rate has played a very limited role in the 1980-83 period and imports of most of these items have been canalized through various Government parastatal organizations which regulate both quantities and domes- tic selling price. As a result there was little price induced substitution of imported raw materials even for export production. This experience illustrates the general point that price decontrol in the Indian domestic market has probably had less than its potential impact on efficiency in either producing or consuming industries in the absence of freer access to imports at reasonable tariff levels. 1/ The list of key input- for which international and domestic price comparisons have been made includes: cotton, steel, copper, aluminum, naphtha, industrial alcohol, zinc, lead, sulphur, newsprint, soda ash, pvc resin, caustic soda, caprolactum, and rubber. 2/ Steel prices and production targets are now set/coordinated through the Joint Plant Committee, a body representing each of the major integrated steel units. Table VI.9: INDEX OF RELATIVE PRICES (international: domestic in US 1973/74 = 100) Ratio Int'1 tv DomesLic Item erice 1973174 1974175 1975/76 1976177 1977/78 1978/79 1979/80 190/81 1981/82 1982/83 1983/84 Raw Cotton (2.80) 100.00 98.82 116.60 b5.28 80.00 101.15 92.2U BU.05 68.53 75.97 77.!9 Steel plates (1.36) 100.00 108.36 125.70 122.81 159.00 164.91 164.37 163.16 122.U4 86.32 104.39 Copper (0.68) 100.UU 76.08 57.87 66.u9 67.26 69.38 76.42 71.66 67.79 64.61 54.55 Aluminum (0.51) 100.00 136.49 152.33 143.62 152.95 149.05 157.61 154.51 166.65 166.92 173.14 1 Naphtha (2.57) 100.00 87.01 65.92 bU.4a 68.97 140.16 1UU.96 88.78 74.76 bU.21 60.12 g Zinc (0.94) 100.00 70.59 25.54 29.84 46.88 52.24 52.41 49.89 50.29 4U.48 41.10 9' Lead (0.69) 100.00 77.89 101.93 122.04 83.02 80.95 99.63 67.59 76.89 66.01 58.74 Newsprint (1.10) 100.00 66.67 71.02 63.13 64.59 74.16 70.17 66.12 81.82 76.30 71.07 Soda Ash (0.67) 1UO.UU 95.46 87.50 100.00 92.31 103.85 93.75 58.70 61.36 54.00 54.00 PVC Resin (0.11) 100.00 145.03 228.45 235.56 230.44 229.91 190.72 165.11 166.67 166.17 153.98 Caustic Soda (0.69) 100.UU 90.U4 82.21 107.51 121.21 133.82 87.27 55.54 55.94 55.94 55.27 Rubber (1.24) 100.00 7b.78 67.48 101.84 95.46 74.39 77.18 78.66 55.80 44.15 62.49 Weighted index 100.00 103.05 116.24 106.25 121.43 132.33 127.34 120.2U 98.67 84.33 92.74 Source: Industrial Development Services, Changes in Prices of Key Inputs, Dratt Report to the World BanK, Delni, 1984. -187- E. The Impact of Domestic Industrial Policies on Costs 39. Another means by which the productivity of Indian industry and thereby its international competitiveness could have improved during the 1980s is through domestic policy changes, to encourage growth or entry in the domestic market. The panoply of controls which regulate and influence Indian industry has been identified as a major factor responsible for the decelera- tion of industrial growth in India after the initial spurt of the late 1950s and early 1960s. Consistent with the deterioration in performance, the period between 1966 and 1974 is generally characterized as a restrictive phase of Indian industrial policy. Flexibility in capacity licensing was progressively reduced, and various restrictive pieces of legislation were implemented including MRTP, which regulates monopoly power through investment controls. PERA, which provides for the indegenization of fcreign owned firms as well, with few exceptions, as restricting the share of equity under any future foreign investment to less than 40%. The reservation of products for production exclusively by the small-scale sector was begun, and most banks were nationalized with procedures established for the direct allocation of credit. 40. This basic structure of industrial policy has remained in place throughout the 1970s and 1980s, albeit with occasional modifications. In particular, several engineering industries were allowed to diversify; capacity in excess of the licensed limit was recognized or allowed through various rationales (such as modernization, exports, balancing or shift rationalization) automatic expansion of capacity was allowed in selected engineering industries; the scope of licensing was reduced through selective delicensing of some industries and raising the investment limits subject to Licensing. These changes appeared to introduce a measure of flexibility in the system, but a detailed review of the implementation of these and other policy changes indicates that many of those changes which were apparently liberal in intent were hedged by qualifications that substantially reduced their impact (ref. Annex VII). Restrictions were often made on the installa- tion of imported and in some cases even domestic machinery. MRTP/FERA firms or firms producing goods subject to small scale reservation (SSR) were disal- lowed automatic growth or liberal reendorsement of existing capacity. This exception was particularly restrictive as there was a marked increase in the number of commodities subject to small-scale reservation in 1976 and again in 1978. Finally recent amendments to the MRTP Act would appear to sig- nificantly increase the number of firms subject to MRTP regulation. New categories such as "industries subject to special regulation and capacity constraints" were created and expanded with dubious rationale to limit the application of re-endorsement schemes. Ad hoc elements continue to play a major role in policy. MRTP firms, for example, are often given licenses subject to export obligations or, more likely, locational restrictions. Both discourage the firm from acting on the license and the latter ensures that if the investment is undertaken it will be on a high cost basis. -188- 41. While there is no doubt that liberalization efforts were made in industrial policy particularly during after 1980, any broad impact on the high cost basis of Indian industry appears to have been circumscribed by restrictions reflecting India's multiple policy objectiveb. In contrast, selected policy reforms in particular industries have been more successful. Most notably cement, but also various motor vehicle industries have benefited from a combination of pricing, licensing, and trade policy reforms resulting in a significant and continuing pick-up in investment. The advantage of reforms limited to particular industries, particularly with a history of excess demand, is that generally no form is hurt and the effects on user and supplier industries are generaly positive. In contrast generalized liberalization geared to freer entry or growth of existing ficms in a wide range of manufacturing activities would inevitably put pressure on less efficient firms or entire sub-sectors. 1/ The willingness to confront these adjustment costs is difficult in any country, as U.S. or European efforts to protect textile and leather industries at considerable cost to their economies illustrate. 42. The story that emerges from this overview of trade and industrial policy appears to be one of increasing relative costs uncompensated by struc- tural changes which could have increased productivity. As a result Indian industry has as yet failed to met both its long-term development objectives as well as to contribute to the export effort that must materialize in the next few years if India's approach of maintaining a more open economy is to be sustained. This is not to deny that Indian export performance after 1980 would not have been better in a more dynamic, less protectionist world trade environment. Certainly efforts to achieve that environment should be high on every country's list of bilateral and multilateral objectives. The more progress India makes with modifications to is trade and industrial policies, the more it will gain from improvements in the world economy and trading environment. 1/ Even in the cement industry many firms which had entered the market or expanded when the policy reforms were introduced early in 1982 are now faced with declining profits. Whether the key elements of the reform, partial price decontrol, iree access to imported cement, elimination of freight subsidies will survive if pressures on profits continue even to the point that some operations close down, is the true test of the reform. -189- WORKING PAPER VI Attachment 1 THE INDIAN TARIFF SYSTEM: SOME PROBLEMS AND CONSEQUENCES Introduction 1.1 Since independence the Indian trade regime has been dominated by quantitative controls on imports, so that until quite recently the level and structure of import duties had a limited role in determining the level of the domestic prices of tradeable goods and the effective protection of local industries. However, in recent years import controls have been relaxed considerably, mainly by placing more and more items - almost entirely inter- mediate and capital goods - on "Open General License" (OGL), 1/ by expanding the number and scope of the various export incentive schemes which allow the import of intermediate materials for export production, 2/ and by the "global tender" policy for capital goods needed by 13 specified industries, which was introduced in 1978/79. Under this last policy the 13 industries (which include most of the large capital intensive industries in India, e.g. fertilizers, electric power, petroleum, petro-chemicals, sugar, cement) can call world-wide tenders for capital goods, which are decided on the basis of c.i.f. import prices plus tariff versus Indian bids irrespective of whether 1/ Unless they are included in various lists of banned or restricted items, all intermediate materials can now be imported on OGL conditions. The principal OGL condition is that the imports must be cleared as being compatible with the many "indigenization" programs administered by the industrial licensing authorities. Under these programs manufacturing firms are obliged to incorporate specified quantities or values of locally produced materials or components in their products. A license is required to import any capital good not in an GCL list or covered by some other special provision allowing it to be imported: however, the scope of these lists and special provisions is now much greater than in the past. The import of all consumer goods continues to be banned, unless the product is on an OGL list or is allowed by some other special provision. Imports of consumer goods are almost entirely food products imported by government trading corporations ("canalizing agencies") and pharmaceutical products not produced locally. With a few minor excep- tions (mainly relating to licensed export and trading houses) all imports must be made by "actual users" or the canalizing agencies, i.e. the normal intermediary functions provided by specialized importers in most other countries are not allowed except insofar as they are provided for in the limited list of products handled by the canalizing agencies. 2/ Apart from the free trade zones, the relevant export schemes are the 100% Export Oriented Units (EOU) scheme and the Advanced Licensing (AL) scheme. -190- import banu, quotas or indigenization requirements would otherwise protect the Indian suppliers. Moreover, the Indian tenderera can import raw materials and corponents regardless of any import restriction or indigeniza- tion rcquirement which would otherwise apply, at an import duty rate which is not to excted the rate on the particular capital goods. 1.2 As a result of Lhe above and ather more naLrowly baned measures relaxing import controls, the government in now paying more attention to the tariff system and will need to pay even more attention to tariffs if the process of liberalizing imports and other direct controls continues during the rest of 1980s. In this regard a number of problems are already apparent and will become more acute in the future. Before discussing these problemn some evidence on the Level and structure of tariffs is summarized. The Level of Tariffs 1.3 Because of the extreme complexity of the Indian tariff system, 1/ quantifying the level of and trends in tariffs is difficult, and in par- ticular is complicated by the large number of (mostly partial) exemptions from the basic customs duty and auxiliary duties. These partial exemptons are mainly for intermediate goods and capit4l goods imported by local industries, while there are complete exemptions under the various export incentive schemes. The consequence of the exemptions is that the tariffs imposed on goods which are actually imported are frequently considerably lower than the basic and auxiliary duties found in the tariff schedules. However, as discussed later the existence of the exemptions does not neces- sarily imply that protection to local industries which is or would be afforded by the tariff (in the absence of quantitative restrictions) is lower than the scheduled tariffs. This is because the exemptions are to a large extent applied to intermediate and capital goods not produced in India, in which case the effect is to increase the effective protection available to the industries which use them. The effect is to reduce the level cf pretec- tion only when the imports are competing with local industries, although all 1/ The Indian tariff consists of: (a) A schedule of basic ad vaLorem (Z) customs duties, appliad to the c.i.f. price; (b) Auxiliary duties of 40% or 30% applied to the c.;.f. price; (c) Additional (or countervailing) duties equivalent to excise taxes imposea on local producers, and usually applied as a percentage of t*e c.i.f. price plus the basic customs duty and auxiliary duty. There are very few specific tariffs. The complexity of the aystem is mainly due to the very large number of "exemptions" (zero or reduced rates) which muit be traced separately for each of the three above components. The most important exemptions are preferential rates on certain products imported from countries with which India has trade agreements and special low rates on particular intermediate or capital goods when used by ipecified local industries. -191- tariff exemptions will of course have an effect (which could be positive or negative) on the effective protection of potential Indian industries. 1.4 Despite the importance of tariff exemptions, the level of structure of the basic customs and auxiliary duties is important since unlenn new exes)ptions or more general changes are made, thene will become the principal instruments of protection insofar an import bana and other quantitative restrictions are relaxed. In thin regard it in striking that the general level i. many times higher than typical tariffs in duveloped countries. Thus in an analysis of tariffs (basic piu& auxiliary) on 525 items in 1977, the Alexander Committee 1/ found that only about 8% were less than 40%. 26% were between 40% and 75%, 38% were between 75% and 100%, 0.6% were between 1002 and 120%, and 27% exceeded 120%. Among the very high tariffs, rates of even 200% and 300% were common, with a maximum of 450%. The Committee felt that the very high tariffs were excessive and recommended a ceiling of 100%, and a maximum for capital goods of 40%. 1.5 Despite this recommendation of the Alexander Committee, between 1977 and 1982 the standard scheduled tariffs which were not subject to exemptions increased rather than decreased. A comparison of 46 Chapters of the Tariff Schedule in 1977 and 1982, found that the average schedule tariff (basic plus auxiliary) increased in every case when weighted by imports, and in every case except one taking simple averages of those items for which there were imports in both years. 2/ For most Chapters the increases were between 10 and 20 percentage points, and in several Chapters the average incresse was about 30 percent points. The principal reasons for these across-the board increases were increases (mostly of 10 to 15 percentage points) in the stand- ard auxiliary duty rates. In addition there were some large increases in a number of basic customs duties, e.g., from 100 to 150 percent for paints; from 60 to 100 percent for dyes; from 100 to 200 percent for synthetic yarns; from 60 to 300 percent for alloy and high carbon steel products. Taking the simple averages of the imported weighted averages for each Customs Chapter gives the following distribution of average tariffs in 1982: 1/ Report of the Committee on Import-Export Policies and Procedures (Alexander Committee), Ministry of Commerce, Government of India, January 1978, Table 9, p. 94. 2/ V.R. Panchamukhi: Indian Custom Tariff: Some Aspects of Structural Changes (mimeo 1984). The 46 Chapters were those ior manufactured products for which imports were recorded in these years. Chapters 1 to 27 (mainly primary products) and 90 to 100 were not covered. -192- Average tariff 1982 Simple average (Basic plus auxiliary Fuwoer of of weighted weighted by imports in Customs Chapter 1981-82 (M)) Chapters averages (%) 50 1 22 50 - 100 32 74 101 - 150 11 133 151 - 200 1 170 200 1 367 46 114 Similar computations 1/ for 78 inpat-output sectors using the basic customs duty only but weighting respectively by imports, gross output and total sectoral supply (imports plus gross output) show the same basic results viz. an increase in tariffs between 1977 and 1982, and the generally high level of tariffs. Moreover, in four of six sectoral aggregations the output and total-supply weighted average duties exceed the import reighted duties. 1.6 After 1982 there was a further increase of 10 percentage points in the across-the-board auxiliary duties, the standard "slab" rate corresponding to basic customs duties of 60% or more being increased from 30-40% and the standard rate corresponding to basic customs duties of less than 60% being increased from 20-30%. However, in 1983 and 1984 sweeping reductions were made to the basic customs tariffs in a number of important Chapters, mainly covering chemicals, iron and steel, metal and metal products, and machinery. Thus substantial reductions were made in chemical tariffs (Chapters 28 to 38), with 200% rates generally being reduced to 150 or 100 percent, 150% rates being reduced to 100 or 110 percent and 100% rates to 60 or 70%. Similarly in Chapter 73 tariffs of 100% on iron and steel were reduced to 70% and 60% rates were reduced to 45 or 40%. In addition stainless steel tariffs on many items used by specific local industries ere reduced from 300% to 40%. Reductions were also made in the Chapters covering other metal and metal products (copper, aluminium, lead and zinc) with 100% tariffs being reduced to a range of between 40 and 85%. Finally, in the important Chapters 84 and 85 covering non-electrical and electrical machinery, a large number of auxiliary duties were reduced from 30 or 40% to 25%, while reductions in basic tariffs were made for may machines required by specific local industries, notably the electronics industry. 1.7 No systematic analysis of the 1983 and 1984 tariff revisions is available, but the net effect for chemicals, iron and steel, metals and metal products and machinery has probably been to at least cancel out the increase in tariffs which occurred between 1977 and 1982, and perhaps to bring the 11 Ibid Tables 9 and 10. -193- average below the 1977 level. However, for other products for which there were no similar across-the-board reduction in basic customs duties the average level of tariffs has probably increased beyond the 1982 level due to the increase in the standard auxiliary rates. The Structure of -L-riffs 1.8 As in most countries, tariffs in India tend to increase with the degree of processing, with the result that the effective protection available from tariffs is generally higher than the nominal protection to output, while available effective tariff protection tends to increase with the various stages in the processing chain. However, the variance and degree of escala- tion of Indian tariffs is smaller than in many other developing countries, so that extreme escalation of effective protection and conversely relative disprotection of activities for which input tariffs are higher than output tariffs would be less of a problem in India than elsewhere if the basic customs and auxiliary import duties were the sole determinants of nominal protection, i.e. if there were no quantitative restrictions, tariff exemp- tions and other measures. This moderate escalation can be seen from the following total-supply-weighted average basic customs tariffs for 1982. 1/ Percent 19 Primary Product Sectors 41.7 6 Semi-processed Product Sectors 65.5 53 Processed/Finished Product Sectors 86.4 Moreover, when the same sectors are classified according to whether they produce consumer goods (average tariff 67.3%), intermediate goods (average tariff 62.8%) or capital goods (average tariff 68.5%) the structure is quite uniform, in marked contrast to many developing countries where tariffs on intermediate and capital goods are considerably lower than tariffs on final ccnsumer goods. The greater uniformity of tariffs in India is doubtless related to the great diversity of agricultural, mineral and manufactured goods which are domestically produced and in particular to the early and continuing policies of developing so-called "heavy" industries producing intermediate goods such as steel and chemicals, and industries producing machinery and other types of capital equipment. 1.9 The relative uniformity of Indian tariffs is illustrated below by comparing the tariffs on the principal inputs with the output ta:iffs for a few products chosen at random from the Customs Schedule. 11 Panchamukhi, op.cit. The escalation would have been somewhat greater if auxiliary duties had been included. -194- Tariff (basic customs plus auxiliary) (W) 1. Knitted Fabrics 140 Knitted Garments 140 2. Cotton Fabrics Synthetic and Blended Fabrics 140 Garments 140 3. Flat Glass 140 Kost Glass Products 140 4. Iron Ore 70 Coal 70 Pig Iron 70 5. Pig Iron 70 Basic Steel (bars, shapes, rods, strip, etc.) 100 . Basic Steel 100 Steel Products (tubes, tanks, wire and wire products, etc.) 110 Nevertheless there are cases of quite marked positive escalation of tariffs, and a certain incidence of negative escalation, i.e. average input tariffs exceeding output tariffs by a significant margin. Three important examples of the former are the important Chapters of the Tariff Schedule covering wool textiles and cotton textiles, and the tariffs for polyester filament yarns. On the other hand polyester-cotton blended fabrics containing normal propor- tions of polyester yarn (over 50%) is an example of negative escalation. -195- Tariff (basic plus auxiliary) percent 7. Raw Wool and Wool Tops 40 Wool Yarns 60 Wool Fabrics 100 8. Raw Cotton 40 Cotton Yarn 100 Cotton Fabrics 140 9. Polyester Fiber 185 + Rs 9/Kilo Polyester Filament Yarn 240 + Rs 30/Kilo 10. Cotton Yarn 100 Polyester Filament Yarn 240 + Rs 30/Kilo Polyester Cotton Fabrics 140 Another example of reverse tariff escalation occurs in non-electrical machinery, for which principal steel inputs carry tariffs at about the same rate as the finished products, while components and consumables (which account for between 15 and 60% of total material costs) are subject to higher tariffs; for example 80% on bearin3s and 167% on electrodes. Some Problems 1.10 Although in principle relative cariffs and not their absolute level is what matters for resource allocation, in India for a number of reasons there is no doubt that the most important problem with the tariff system is that the general level of basic and auxiliary duties is too high. 1.11 Even if the variance of import-substitution protection were not large, the generally high level of these duties and the high EPRs that these make available to import substitution producticn means that unless substan- tial tariff exemptions or other offsetting measures are taken, incentives for exports will generally be less than incentives for domestic sales. This is obviously true as regards primary commodity exports and is also true for manufactured exports even when all the presently available export incentives are applied. Thus, in 1980-81, the average nominal export incentive rate for a sample of 13 products and 45 firms analyzed by ICICI was 19.2%. 1/ Since these inceutives included duty drawback as well as cash compensatory support and replenishment licenses, the 19.2% rate (which ranged from 3.7% for sheet glass to a maximum of 33.8% for cables) can oe considered the export equiv- alent of import tariffs. They are clearly well below the general level of the tariffs applied to the same and other products so that exporting is only 1/ ICICI, Export Study (Draft mimeo 1983). -196- likely to be profitable relative to domestic sales when price controls or competition between domestic firms depress local prices well below the levels that would otherwise be permitted b;;y tariffs. 1.12 Perhaps one of the most important consequences of a very high general level of tariffs is that even if the tariffs themselves are not very dispersed, it is inevitable that there will be a very high incidence of redundant protection which will in turn lead to large variability of EPRs and correspondingly large distortions in resource allocation. Such redundant protection can occur for a variety of reasons including zero or low export incentives for domestically produced exportable primary inputs, tariff exemp- tions granted to special interests or for special reasons and price controls imposed to limit excess profits. 1.13 The existence of tariffs which would in many cases effectively block or discourage imports competitive with local production is inconsistent with a major benefit from tLe removal of quantitative import restrictions, namely competition and cost disci'pline for local producers. 1.14 Even when tariffs on inputs are fairly uniform, high nominal tariffs translate into high effective tariff protection. Thus, if the tariff on the principal material inputs is 145% and the output tariff is 145% (as is the case with knitted goods and garments referred to previously) the available effective tariff protection is also 145%. 1/ With such high tariffs even moderate upward escalation between average input tariffs and the output tariff w11 correspond to even higher levels of effective protection, with the magnification effect increasing with the degree of escalation. For example, the present 40% tariff on raw cotton and the 100% tariff on cotton yarn would give effective tariff protection of about 280% for cotton yarn processing, wtile the 100% cotton yarn tariff and the 140% cotton fabric tariff would correspond to effective tariff protection of about 200% for grey fabric processing. 2/ 1.15 The high gen-2ral level of tariffs has well known and serious conse- qxences for the administration of the Customs system because of the iLcentive for smuggling. In many countries Customs revenues have increased substan- tially following tariff cuts both because oi the elasticity of imports and because of the redirection of smuggled goods to official channels. High 1/ This abstracts from some (usually minor) complications relating to non-traded irputs and capital equipment. 2/ These calculations assume ratios of world-price value-added to final product world prices of 25% for yarn production and 40% for grey fabric production. They are meant to illustrate the protection potentially available from present customs and auxiliary duties. not the actual realised effective protection of these industries. -197- tariffs also pose serious problems for the administration of export incentive schemes because of the profitability of diverting both raw materials and finished products on to the domestic market. This in turn tends to lead to a proliferation of controls and checks on ezporters which may be counterproduc- tive by largely offsetting the advantage of the export incentives themselves. Restrictions on the duty-free advance licensing scheme which is the most effective means of providing imported inputs to exporters at international prices illustrate this problem. 1.16 The high incidence of redundant protection associated with high tariffs increases the risks faced by manufacturers who use export incentive schemes. This is because these schemes nGrmally require that if a final product is not exported or a raw material purchased an duty-free or drawback c-inditions is not used (because of the cancellation of an export order, for example) that the normal import duty should be paid before the product can be sold in the domestic market. If the import duty is high relative to the domestic price (i.e., if there is redundant protection) this involves the exporter in an extra loss over and above the commercial loss which will normally be involved. 1/ Future Directions 1.17 This review of the consequences of India's high tariff levels clearly indicates that a decline in these levels must accompany further efforts to relax quantitative restrictions. Although short-term revenue requirements have led to contrary pressures on tariffs, failure to counteract these pres- sures and to take a broader perspective on the role of tariffs in the economy will threaten the prospects for reversing the secular decline in the produc- tivity of resource use in India and attaining more rapid growth. And ultimately growth is itself the source of resources for India's further development and for achieving her broader socio-economic objectives. 1/ In the present Indian system the risks are even higher because of quantitative restrictions which prevent domestic sales of many materials and products altogether. Domestic sales would however be allowed in a normal tariff-based system, providing the appropriate tariffs are paid. For example, with drawback the duty on the intermediate input would not be refunded and the final product could then be sold in the domestic market. W(MKING kAPER VI Attachment II CQ4MOp)iTy Administrative Controlled or Price not Statutorily Higher Price Body tar Asport Price ControlLed ___ (Domestic/IntL.) lPrice _ixa1%on Method at Frice Fixation ana Remarks Aluminum domestic Aluminum Taxes into account diftering cost structure of indigenous producer Controller due to difterences in power tarift, as well as the import costs to KMrC. Prices are tiled so as to neutralize ditterences in final selling price of imported and indigenous aluminum. Steel international Joint Plan Since April 1982, prices tor pig iron and all categories of steel Committee troa integrated steel plants are fixed by JPC, son prior Covernment approval is not required. Naphtha international Cabinet on advice Pricing tar naphtha is based on the principle that naphtha price for of Ministry of tertilizers shoild be less than tor petrochemicals. The overall Petroleum and at pricing policy tor petroleum products is based on the principle that Vinance the low price of certPan oil products is offset by higher pricing for other products. Newsprint domestic Newsprint Pricing Prices o importen newsprint are fixed by NPC on basis of "pooled Committee price" of supplies from ditterent sources, Since 1VAU, prices of indigenous newsprint are linked to international prices. Zinc domestic ) Pricing Committee Indian prices are linked to prices at commodity in London Metal lAnd domestic ) at which MhTC is Exchange. Prices are tixed every montn taking into account cost of Copper domestic ) part HTC's stocks, prevailing domestic market rates, and various duties and additional charges, as well as changes in the exchange rate. Raw Cotton international Agricultural Prices There are no statutory floor or ceiling prices. Support prices for (support Commission cotton growers are tixed by AYC, and CCI carries out "support price) Cotton Corpoiation operations" to ensure minimum support prices to cotton grovers. oa India Rubber domestic Rubber Pricing Indigenous producers are tree to tix own price. Imported rubber price Committee of wnich is fixea Dy RPC including actual cost plus various other charges and SIC is part custom duty. Custom auty is adjusted regularly in order to narrow the difterence between indigenous and domestic product and protect the interests ut the domestic producers. Soda Ash domestic Prices are fixed by inoigenous manutacturers on the basis at production YVC Resin cost. However, Uovernment regulates the price of the commodity by Caustic Soda adjusting excise duty on indigenous production and import duty. Tnese duties are used to level the prices of imported and indigenous products. -199- WORKING PAPER VII REVIEW OF INDUSTRIAL LICENSING POLICY (1951-85) Prepared by Sunanda Sengupta -200- WORKINC PAPER VII REVIEW OF INDUSTRIAL LICENSING POLICY (1951-85) Page No. A. Introduction..................************............ . 202 B. The Basic Policy Framework...................o.o.. ...... .... 203 C. Regulation of Capacity....................................... 205 (i) The Industrial Development and Regulation Act, 1951..... 205 (ii) Investment Policy...............i.cy......... 205 (iii) Review of Licensing................................... 206 D. The Liberal Phase - The Pre-1969 Years......7................ 207 (i) The Initial Years, 1951-58............................. 207 (ii) The Critical Years, 1958-64........................... 208 (iii) The Years of Introspection and Public Criticism of Policy, 1964-65........... .......... 210 E. The Restrictive Phase - 1969-74............................... 211 (i) The Regulation of Economic Power...................... 212 (ii) Regulation of Foreign Investment....................... 214 (iii) Licensing Policy Decisions............................. 215 F. The Decade of Structural Adjustment - 1974-83............... 218 (i) Structural Adjustment to the First Oil Price Shock...... 218 (ii) The Post-1979 Years: Adjustment to the Second Shock..... 221 C. Recent Policy Trends: The Post-1983 Period.................. 226 H. Some Concluding Observations.................................. 228 (i) Impact of Licensing Policy on the Structure of Manufacturing............................ 228 (ii) Agenda for Change....... ...... 231 (iii) The Statistical Base: Its Inadequacies and Suggestions for Improvements.....,........ .. .... 232 Attachment 1: List of Industries in Schedules A and B, Industrial Policy Resolution of 1956............. 234 Attachment 2(a): List of "Core" Industriesd.t...r.i.. .......... 236 Attachment 2(b): List of "Appendix I" Industries.................. 237 Attachment 2(c): Revised List of Appendix I of 1973 Policy...... 239 -201- Attachment 3(a): List of Industries Requiring Special Regulation (February 1973 Policy).............. 243 Attachment 3(b): List of Industries Requiring Special Regulation (as of October 1984)................ 245 Attachment 4: List of Industries Allowed Automazic Crowth........ 248 Attachment 5: List of Industries Exempt from MRTP Act............ 254 Attachment 6: Raising The Investment Limits for Determining Dominance and Concentration of Economic Power.... 256 Attachment 7: Suggested Range of Size Classification for the Medium- and Large-Scale Sector................... 258 Tables VII.1 Industrial Policy Liberalization Measures and Conditions Circumscribing Eligibility.................... -202- WORKING PAPER VII 1/ REVIEW OF INDUSTRIAL LICENSING POLICY (1951-85) A. Introduction 1. Within the relatively short period of three decades of planned development, there has been radical transformation in the ownership and structure of the manufacturing industry. Consistent with the ideological framework of a socialist State, the public sector has expanded from a rela- tively negligible base to acquire control of basic key and strategic industries popularly referred to as "the commanding heights of the economy". At the same time the small-scale sector has been carefully nurtured, and protected, so as to compete with the large-scale private sector in many products areas, while the level of foreign ownership has been vastly reduced. Structurally, a balanced base with developed capital, intermediate and con- sumer goods has emerged, contributing to extensive diversification of output, which is fairly evenly distributed across regions. 2. The achievement of some of India's structural and ideological objec- tives in industry appears to have taken place at the cost of other economic objectives, primarily growth of output and employment. Since the mid-sixties the major areas of serious concern with respect to industrial development strategy have included: the stagnation and slow growth of capacity in some sectors coupled with the emergence of sizeable unutilized capacity and slow growth of output in others; the high cost of manufacturing activity - in turn a reflection of low productivity and technological obsolescence; and stagna- tion in industrial employment. The limited objectives of this paper are to analyze the policy environment in which industrial planning has taken place and to attempt to identify some of che aspects of the regulatory mechanism and implementation strategy which could have contributed to the malaise in the system. 3. Initially, within the planning framework of heavy industrialization and the development of capital-intensive industries required in the Mahalanobis planning model, the broad strategy parameters were to (a) socialize the ownership of the means of production of the key sectors; (b) outside these sectors, channel investable resources of the private sector into pre-determined priority activities; and (c) widen the industrialization effort to achieve a more equitable distribution of the benefits of growth. The expansion of the public sector took place through a combination of measures including nationalization, takeover of sick or inefficient private sector units and the establishment of new undertakings both at the Central 1/ This Working Paper, together with six others, supports the analysis in Chapter 2 of the Report, India: Structural Zhange and Development Perspectives, Report No. 5593-IN, dated April 24, 1985. -203- and State level. Industrial licensing on the other hand became the primary instrument to regulate the direction of investment in the private sector and to spread the benefits of industrialization through geographical dispersal of industries, diffusion of the entrepreneurial base the promotion of modern small-scale undertakings. 4. The overall direction of licensing strategy rested on the policy framework provided by the Industrial Policy Resolution of 1956 and supple- mented subsequently by policy decisions announced in February 1970, and 1973, July 1980 and August 1982. The legislative support came from three principal Acts of Parliament: (a) the Industrial Development and Regulation Act 1951 (IDRA); (b) the Monopolies and Restrictive Tiade Practices Act 1969 (MRTP); and (c) the Foreign Exchange Regulation Act 1974 (FERA). B. The Basic Policy Framework 5. The pronounced socialistic leanings of the Indian National Congress in the pre-Independence years inevitably paved the way for State intervention in industrial planning. The 1948 Resolution was the first official statement of policy which clearly recognized a dominant role for the State in the development of basic capital-intensive industries and the need for regulation of private sector investment. With the formal adoption of a Socialistic Pattern of State by the Parliament in 1954 it was felt that a revised policy statement was required to reflect more clearly the political aspirations of the State. Thus, in 1956 a second policy statement was issued to incorporate the ideological spirit of the Constitution 1/ which required the State to direct its policy towards ensuring (a) that the ownership and control of the natural resources of the community was so distributed as best to serve the common good, and (b) that the operation of the economic system did not result in the concentration of wealth and means of production to the common detriment. 6. The 1956 Policy Resolution reiterated the importance of increasing the responsibility of the State in the future development of industries over a wider area. Its most significant feature was the classification of industries into three schedules. Schedule A consisted of industries whose future development was to be largely the exclusive responsibility of the State. Schedule B consisted of industries to be progressively State owned, and in which the State would take the initiative in establishing new undertakings, although at the same time its efforts would be supplemented by the private sector. 2/ All other industries were placed in the third Schedule and were to be developed at che initiative of the private sector, but it 1/ The Directive Principles of State Policy (Article 39). 2/ See Attachment I. -204- would be the responsibility of the State to develop the necessary infrastructure. 7. In many ways, the Resolution was a compromise of conflicting inter- ests and therefore it is not surprising that its interpretation has fltlc- tuated from time to time. The mose remarkable aspect was that in practice it provided tremendous flexibility to policy makers, since the three schedules of industries were not placed in watertight groups. In theory the Policy permitted not only expansion of private sector units operating in Schedule A industries, but also allowed new undertakings to be established in that group if considered necessary to the national interest. In other cases private units also could be permitted to produce an item within Schedule A for meeting their own requirements, or as by-products. Similarly, there was no ban on public sector entry in the third category of industries. 1/ 8. Apart from flexibility the 1956 Policy placed emphasis on developing a complementary relationship between the public and private sector, as well as between the small- and the large-scale sectors. The Resolutior. enunciated the broad principles of industrial planning. These were: reduction in income disparity and prevention of monopolies and concentration of economic power; progressive reduction of disparities in levels of development between regions; encouragement of cottage, village and small-scale industries to improve their competitive position; and fair and non-discriminatory treatment of public and private sector units where they co-existed. Other policy objectives included efficient operation of public enterprises, development of technical and managerial per3onnel; maintenance of industrial peace; improve- ment of productivity and living conditions of workers, and participation of workers and professionals in mangement. 9. The 1956 Policy Resolution was primariLy a statement of desired objectives in industrial planning. The underlying assumptions were that industrial licensing would be automatically used as an instrument to achieve these objectives, and that the regulatory powers to be exercised through the IDR Act of 1951 would suffice. As will be seen from the section below many of these policy objectives were not addressed sufficiently. In part this was a weakness in the regulatory system, under which no clear directives were issued to the licensing authorities to follow accepted guidelines. In part it reflected certain inadequacies in the control system itself which came to be rectified much later through additional legislation. Thus the regulation of monopolies and the prevention of concentration of economic power remained a policy objective on paper until the MRTP Act was enacted in 1969. 1/ It is this flexibility in the 1956 Resolution that enabled the Government recently to open up the telecommunications sector for private enterprise. -205- Similarly the legal sanction behind a policy of product reservation for the SSI was obtained only with the 1984 Amendment of the IDA Act. C. Regulation of Capacity (i) The Industrial Development & Regulation Act, 1951 10. The most significant practical instrument of India's industrial control mechanism has been tb regulation of capacity growth through industrial licensing. Introduced under the Industrial Development and Regulation Act (IDR) of 1951, licensing emerged as the principal instrument for channeLing scarce investable resources into priority sectors of national importance. The IDRA of 1951 provides for the registration and licensing of industrial undertakings for carrying on business, substantial expansion and starting new undertakings in any of the industries listed in the Schedule to the Act. In granting licenses the Act empowers the Government to specify conditions regarding location of undertakings and minimum standards in respect of capacity and to exempt undertakings from licensing provisions on the basis of smallness of size of investment, or employment. The Act also gives sweeping powers to the Government to investigate the workings of a company, to issue necessary directives in respect of prices, production, quality and the management of the undertakings, and to 'take over' management of undertakings in the public interest. Interestingly the powers of takeover cannot be challenged in a court of law. Comprehensive powers to control and regulate the supply, distribution and pricing of manufactured arti Les are also incorporated in the legislation. (ii) Investment Policy 11. Unlike agriculture, the market mechanism has a limited role in shap- ing investment planning and policy in industry, especially in the private sector. At the macro level, the volume of investment, its sectoral distribu- tion and mix reflect both the choices inherent in the planning exercise, and the strategy of industrialization with policy emphasis on growth versus otLr considerations such as regional development, the promotion of the public sector, the small-scale sector, cooperatives and the joint sector, and the regulation of economic power. Investment direction, however, is the outcome of sectoral capacity gaps, resource mobilization and allocation to the public sector, and the finer regulations governing investment opportunities in each sector, covering various aspects such as licensing, prices, product mix and distribution. The existence of investment opportunities, their identifica- tion and a favorable regulatory environment are only some of the major ingredients of investment policy. Other considerations influencing invest- ment policy relate to returns on investments which would depend on (a) fiscal policies concerning indirect taxes such as import duties, excise taxes, the structure of direct corporate taxes, tax shelters--bcth general and industry specific--and subsidies, etc. and (b) the cost of capital. Much would depend on the financing package and its mix between internally generated resources, -206- concessional assistance from financial institutions and banks and borrowings from the capital market. 12. Tn contrast to the public sector, the planning process refrains from detailed investment planning in financial terms for the private manufacturing sector. Some broad estimates are generally made by industry associations and Government, to provide some guidance on the question of budgetary support required by the financial institutions and policy support to the capital market. Detailed capacity planning of major products is a part of the Five Year Plan exercise, the division between public and private sector depending on availability of resources for the former. The private sector picks up the residual balance. The actual level of investment, its composition and dis- tribution among the constituents of the private sector are determined by industrial licensing. (iii) Review of Licensing 13. In the first two decades after it was introduced, licensing seldom became a binding constraint on capacity growth. In fact the administration of industrial licensing was fairly liberal and licensing authorities were given a free hand with no policy directives to follow, other than the broad overall strategy of industrial planning indicated in the Industrial Policy Resolution of 1956. it is only later that various criteria came to be imposed on the issuing of licenses, in response to populist socio-economic pressures which arose from time to time. These contributed directly to major shifts in the structure of manufacturing industry, the ownership pattern of assets and growth of output, employment and investment. 14. In fact, in reviewing the trends in industrial licensing over the years 1951-85, four distinct psriods stand out: the years 1951-69, when lice;sing policy was relatively liberal; the years of intensive regulation, 1969-74; the years of mixed policies, 1974-83; and the post-1983 period. The years up to 1969 were in many ways a learning period in the use of the con- trol mechanism, and actually resulted in an abuse of the system by the private sector, which used the restrictions on entry to consolidate monopo- listic and economic power. Much of the rigidity that came into the syst--m in the second period 1969-74 could be seen as a reaction to these abuses. The attempts at liberalization in licensing in the decade 1974-83 were initiated in response to the overriding need for greater efficiency in the economy following the aftermaths of two successive oil price increases in 1973 and 1979. In practice, the liberalization in licensing was, however, subject to many conditions, and its effect was at least partly negated by the imposition of other regulatory measures. -207- D. The Liberal Phase - The Pre-1969 Years (i) The Initial Years, 1951-58 15. The pre-1969 years, spanning two decades, could be further classified into three sub-periods: the initial years 1951-58; the critical years of import substitution, 1958-64; and the years of introspection and public criticism of policy, 1964-69. The initial years were remarkably free from a doctrinaire approach to industrial growth strategy. In the implementation of licensing policy four criteria came to be developed. These were: (a) planning the growth of capacity at differential rates; (b) correcting technological obsolescence; (c) promoting geographical decentralization of strategic industries; and (d) broadening of the entrepreneurial base. 16. Capacity planning at differential rates was introduced to correct existing imbalances in the industrial structure. They were in conformity with the broad capacity targets indicated in Plan documents. To illustrate this point, licenses were given fairly liberally to the chemical and engineering industries, which were relatively less developed than the cotton textile industry. At the same time related industries such as textile machinery and dyes and chemicals, which were also lagging, received preferen- tial treatment. In the textile industry itself licenses for looms were given on a limited basis until it was decided tc freeze weaving capacity in the large-scale sector. On the other hand, to promote the decentralized handloom sector licensing policy was fairly lenient in the case of spindles in the mill sector. 1/ 17. Technological obsolescence was to be removed through a policy of laying down a standard scale of operation and not issuing licenses for capacity below the standard minimum. Examples of this can be seen from the way in which the minimum scale of operation increased progressively in the Plan periods in some of the established industries such as cement, sugar and paper. It is interesting to note how this policy was subsequently completely revised to provide positive support to small-scale and frequently uneconomic scales of production through a policy of reservation of spheres of production for small-scale undertakings and increased barriers to capacity growth in che large-scale sector in respect of reserved items. 18. Geographical decentralization of strategic industries became a criterion for licensing, not exactly to correct regional imbalances, but to ensure that basic industries hitherto concentrated in the eastern States were encouraged in other regions, which were not necessarily industrially backward. As a part of this strategy, licenses were issued for engineering industries in the western, northern, and southern parts of the country, and 1/ Phiroz Medhora: Industrial Development, a quarter century review. -208- in support of this policy the principle of freight equalization of key commodities, particularly steel, was introduced. 19. Broadening of the entrepreneurial base through a policy of encourag- ing new entrepreneurs vis-a-vis established producers operated at several levels. In the first instance it encouraged persons with virtually no industrial background to compete. Secondly it consciously encouraged Indian parties to break the monopoly of foreign dominated firms, and lastly it attempted to increase competition between the large houses. The pursuance of this approach would explain the preference shown to Kilachands and Nanu Bhai Jewellers in setting up basic chemical capacity in nylon and synthetic rubber in competition with established large Indian houses; permission for Tatas to enter the tire industry to break the monopoly of foreign companies such as Dunlop and Firestone, and allowing Birlas to establish capacity in almost every industry in which Tatas had a stake. (ii) The Critical Years, 1958-64 20. The years (1958-1964), which mark the pericd of licensing under a strategy of import substitution, were characterized by high growth of capacity, reflected in over 1200 licenses being issued annually. The multi- plicity of objectives which had developed over the early years in the administration of the licensing system continued. However, in response to the acute foreign exchange constraints of the period two other features developed. These were: (a) the progressive indigenization of manufacturing; and (b) joint product licensing. 21. (a) Progressive indigenization in the manufacture of a new product meant that almost all licensees of assembly were forced to take up progres- sive manufacture of the product's components or basic materials within a period of 4-5 years. This happened for instance in the chemical and engineering industries. The rationale for this approach was to reduce dependency on foreign exchange for the import of raw materials and components, but it tended to be implemented indiscriminately, e.g., in cases where components were available indigenously, or where the scale of produc- tion was inappropriate. 22. (b) With the same objective of conserving foreign exchange joint product licensing was encouraged in most cases where two or three components were required in the final item. Thus in the making of fluorescent tubes, the same company had to undertake the production of both the electricai system and the glass shells. In the paper industry, pulp manufacture became a precondition for producing paper. This again often led to mismatching capacities of intermediates and finished goods, frequently burdening firms with excess capacity in one stage or the other. A typical illustration is provided by the glass industry, where a handful of efficient glass tube factories would have been sufficient to supply the entire country's requirements. Such units, however, were not allowed to be installed; instead, the licensing system encouraged numerous applications for uneconomic -209- high cost units. One notable exception was the aluminum industry, where manufacturers of cables and extrusions were permitted to purchase their requirements from manufacturers of the base metal. 23. Policies aimed at the broadening of the entrepreneurial base also contributed to fragmentation of capacity into uneconomic units. Once initiated, fragmentation tended to be perpetuated, as the next contenders for license i7i a particular field also had accept the same conditions. Apart from high cost due to uneconomic scale of operation, this policy led to considerable inefficiency in the system as entrepreneurs were compelled to enter areas in which they had no skills or experience. Thus the pursuance of the policy of establishing standard sized plans in the initial years (para 17) was negated by the approach initiated by the policy measures of this period. It is this change in policy that largely set the pattern of technological backwardness and high cost industrial capacity in India. The tendencies it set in motion were further aggravated by the policy of protect- ing the market for the small-scale sector and by an increasing indifference to technology upgrading requirements of the manufacturing industry in the mid-seventies. Indeed, as discussed further below (para 53) Licersing deci- sions of the seventies denied significant parts of industry the opportunity to overcome technological obsolescence. Restrictions were imposed not only on installation of imported machinery, but indigenous equipment as well, all in the interest of containing growth of assets in the large-scale private serttor. 24. The years 1958-64 alqo witnessed phenomenal growth of large houses and monopolies, as there was no effective control on concentration of economic power. There was in fact continuous growth in assets of large houses. Contributing factors were the policy of entrepreneurial diffusion, which encouraged established business houses to venture into new lines; the absence of control on transfers of licenses, which led to open market pur- chase of industrial licenses by the more established business houses; the non-implementation of capacity by new entrepreneurs who lacked experience and by others who were directed to backward regions lacking in infrastructure, and the complex procedures of the licensing system and the inordinate delays which deterred all but the most persistent or the well entrenched business firms. Another aspect was the absence of clear guidelines in licensing policy and the emergence of a system of scrutiny on a discretionary basis, which permitted licensing decisions to be manipulated in favor of large houses. 25. Finally, the liberal licensing of capacity under the strategy of import substitution, and its rapid implementation, created unexpected problems of surplus capacity. In part this reflected the fact that permitted capacity generally was in excess of targetted demand capacity and also because with the bunching of license approvals too many new units tended to enter the market at the same time. Most of the units established during 1958-62 found that the domestic market was far smaller than anticipated. Nor were these nascent industries, often established with secondhand technology -210- in a highly sheltered market, in a position to explore export markets. Another problem was that even for the level of production the market could sustain, these firms were seriously constrained on account of difficulties in obtaining foreign exchange for the import of essential raw materials and equipment. Thus one of the other main objectives of the licensing system, i.e., the close matching of capacity to demand under the aegis of the public planning apparatus, was also not attained. At the same time the non- implementation of licensed capacity created shortages in specific subsectors. (iii) The Years of Introspection and Public Criticism of Policy, 1964-69 26. In the Third Phase (1964-69) efforts were made to redress some of the negative features of licensing. To prevent recurrence of excess capacity, three lists were introduced. The Banned list consisted of industries where installed capacity was sufficient to met projected demand, and in which no further capacity would be permitted. A Merit list indicated industries where capacity expansion would be allowed on a selective basis, and a free list indicated industries where there would be no restrictions on entry. These Lists however achieved very little other than consolidating an existing situation. Basically the underlying philosophy behind absolute and partial barriers to entry-that the State could assume the entrepreneurial function of assessing market demand-remained unchanged. The closed system not only prevented entry of potentially more efficient producers on grounds of ade- quate capacity, but also set up barriers through protection of high cost units. 27. To deal with problem of non-implementation of industrial licenses, the recommendations of the G.L. Mehta Committee were accepted and several hundred licenses were revoked in 1963/64. Licensing procedures were also streamlined and a decision taken to issue a letter of intent in the first round, which would be eligible for conversion to an industrial license only when it could be demonstrated that there had been physical progress in implementation such as purchase of land and erection of factory buildings, etc. Concern with the problem of slow growth of capacity and output also led to the delicensing of 41 industries and the decision to permit substantial expansion of capacity of existing undertakings. Delicensing was upheld on grounds of capacity constraints, and further justified in case of industries which did not require foreign exchange resources for capital equipment or raw materials. Capacity expansion of existing undertakings was limited to 25% of licensed capacity and was applicable both to diversification and to substan- tial expansion. 28. These efforts at reform of the system, however, proved ineffective, and licensing policy came in for a spate of criticism in the mid-sixties. The first protest came from the Monopolies Inquiry Commission (1964) which concluded that licensing restricted the entry of the smaller entrepreneurs and so contributed to further concentration. This view was endorsed by the Administrative Reforms Commission (1968). In the meantime criticism of the system came from S.C. Barve of the Planning Commission (1966), and R. -211- K. Hazari (1967). Barve questioned the wisdom of placing emphasis on tar- getted capacity and pointed out how the non-implementation of capacity resulted in perpetuation of monopolis and chronic shortages. He recommended the refusal of licenses to large houses for 'easy pastures' and the diversion of their energies into industries with long gestation periods involving advanced technology and heavy investment. Hazari pointed out how, in the absence of systematic follow up of the new licenses, influential groups were successful in the foreclosure of licensed capacity. He recommended that licensing policy should indicate priority areas for development and also targets. Once a license was issued the Government should commit itself to providing for both domestic and foreign exchange resources. He recommended the raising of the exemption limit for new undertakings from Rs 2.5 million to Rs 10 million, for a substantial expansion to 25% of the existing licensed capacity or Rs 2.5 million, whichever was more, and for new articles to Rs 2.5 milLion. The study team of the Administrative Reforms Commission on Economic Administration recommended that detailed administrative allocation should be given up and that tariff, credit, fiscal and taxation policies should be utilized to bring about the desired objectives. 29. The public debate on licensing, and criticism from administrators, academicians and left wing politicians finally led to the appointment of the Industrial Licensing Policy Inquiry Committee under the chairmanship of S. Dutt, to examine the working of the licensing system. The Dutt Committee Report (1969) pointed out that the licensing system had failed to meet the objectives of the 1956 Policy primarily because the licensing authorities were never given any specific instructions or set of priorities. It further confirmed the growing concentration of economic power and concluded that the licensing system had favored the large industrial houses; ds had the finan- cial institutions in their lending policies. It reiterated Hazari's conten- tion regarding deliberate pre-emption of capacity, and further exposed the unethical practice of large houses of submitting multiple applications in different names. An important recommendation of the Committee was to permit the partial conversion of loans to corporate units from the public financial institutions into equity. The rationale behind this proposal was to enable the lending institutions to share the benefits of growth, but it induced fears of Government control. E. The Restrictive Phase, 1969-74 30. The six years in this period were extremely critical and mark the most restrictive phase of industrial licensing. The major developments were (a) the enactment of the MRTP Act, which gave the Government sweeping powers to regulate investment activity by large houses and dominant undertakings; (b) the hardening of policy towards foreign investment culminating in the introduction of the third major piece of legislation-the FERA; and (c) the announcement of licensing policy decisions in February 1970 and February 1973 which were to supplement the 1956 Policy Resolution. In contrast to the indifference of the previous phase, the licensing authorities became highly sensitive to the issue of concentration of economic power. Until -212- February 1970 when the new licensing policy was announced, the general prac- tice adopted during this period was one of outright rejection of all applica- tions from large houses. From 1970 onwards licensing policy came to be virtually obsessed with size of undertaking, dominance, and ownership, reflected in severe restrictions on MRTP companies and foreign majority companies for all purposes. 31. Other developments in this period were the abolition of the managing agency system, the Amendment of the IDR Act 1951, the streamlining of licens- ing procedures including the establishment of the Secretariat for Industrial Approvals (SIA), and the introduction of the Projects Approval Board (PAB) to deal with all composite cases requiring several clearances relating to licenses, foreign collaboration of capital goods and KRTP. The existing committees for these clearances were to be treated as standing committees of PAB. A further simplification of procedures was the merging of the Licensing Committee and the Advisory Committee for MRTP Act into a common committee - Licensing cum MRTP Committee. Various time limits were also announced for clearing various types of applications. (i) The Regulation of Economic Power 32. The MRTP Act (1969) introduced a parallel system of regulation other than licensing. The undertakings which come under the purview of the Act were: (a) undertakings with gross assets of Rs 20 crore and above; (b) interconnected undertakings which together have assets of Rs 20 crores and above; (c) dominant undertakings; (d) interconnected undertakings which are dominant. 33. Undertakings covered by the Act require a separate approval from the Central Government for all cases of new undertakings, substantial expansion, mergers, amalgamations and takeovers. 1/ The Government is permitted to give approval only if the investment activity does not lead to further concentration, and is not only not prejudicial to the public interest but is positively in the public interest. In cases of doubt the Government has the 1/ Such approval is however not required for a merger when the undertak- ings are already interconnected, produce the same goods, and are not dominant. In such cases there is ro increase in the market share of the group. Similarly, permission of the Government is not required for a takeover when the two concerned firms are not dominant, and are producing the same goods. -213- discretion to refer such cases to the MRTP Commission, though the decision of the latter is not binding on the Government. The Act provides the Government the discretion to exempt certain types of industries from the application of the Act on the basis of national priorities such as defense needs, market requirements, increase in efficiency, regional growth and economies of scale. 34. Until the two Amendments of the MRTP Act in 1982 and 1984, the Act provided some flexibility to decision-makers. A constraining aspect of the 1982 Amendment was the withdrawal of the facility to expand substantially in the same line of activity - this was earlier permitted to non-dominant undertakings. By way of concession for this harsh amendment, the scope of investment activity by large houses was expanded with the announcement of MRTP exemptions for 9 industries of national priority. The two Amendments narrowed the definition of "dominance" and "interconnection", and thus automatically increased the scope of the Act. 11 35. Originally dominance had been defined in terms of controlling at least one third of the production and supply of a product, and having fixed assets of Rs 10 million and above. Under the 1984 Amendment, the Rs 10 million asset limit was retained, but the controlling share of the market came to be expressed as either one quarter or more of the output or licensed capacity. 36. On the interpretation of interconnection there has been considerable controversy. Initially when the MRTP came into force the definition of interconnection taken from the Monopolies Inquiry Commission and the Dutt Committee was based on management control exercised by the Managing Agency System (MAS). With the abolition of the MAS, a nuLoer of firms which were classified as MRTP companies in the Act claimed deregistration. In turn deregistration prompted the Government to be even more rigorous in defining interconnection through the 1984 Amendment. Currently interconnection can be established between two companies on the basis of common directors, or directors who are related by blood or marriage--over a dozen types of relationships are specified in the Companies Act. 37. To date there has been no official review of the working of the MRTP Act. It has however generated considerable controversy in recent years. While the business community is unequivocal in its condemnation of the restrictive nature of the legislation, left wing academicians have been equally critical of the Act, contending that it has been ineffective in controlling the growth of assets of large houses. In the administration of the Act the Government has been frequently accused of neglecting the Commissior by not referring sufficient numbers of cases. According to a study of the applications under MRTP, there has been a deterrent effect, as 1/ The number of companies registered under the MRTP Act increased from 1238 in 1981 to 1784 in 1984. -214- barely 10% of the total applications for licenses were MRTP cases, of which roughly 10-15% were rejected and another 10-15% referred to the Commission. 1/ 38. It is important to note that it is not always the scope and inter- pretation of the Act, but the dual nature of control being exercised through the licensing policy system in conjunction with the MRTP Act, that accounts for the limited number of cases before the Government and equally few cases being referred to the Commission. In fact the enactment of the MRTP Act was accompanied by a shift in administrative procedure under which the licensing authorities were given clear-cut policy directives with regard to investment proposals from MRTP companies. These directives, issued in the licensing policy announcements made in 1970 and 1973, and again in 1980 and 1982, not only provided guidelines to administrators but also made clear to potential investors from MRTP companies, the areas in which their applications would be entertained. 2/ Thus while the MRTP Act indicated the considerations which should be taken into account while examining MRTP proposals, the licensing policy decisions announced the specific areas in which such proposals would be permitted. 3/ Under these policy announcements most types of investment propGsals were banned and only a handful of MRTP firms were even eligible to file applications for obtaining licenses for new undertakings or expansions. (ii) Regulation of Foreign Investment 39. Official policy towards foreign investment rapidly changed from one of suspicion at the time of Independence, to an open door policy in the late fifties. For almost a decade, which was a crucial period of rapid industrialization under the impetus of import substitution strategy, foreign collaborations were allowed freely with virtually no regulations. By the mid-sixties, however, a cautious approach came to be advocated as it became apparent that a great deal of technology inflow was either obsolete or redundant. Other negative aspects were the repetitive sale of technology, the absence of policies to ensure technology transfer at the shop floor, the import of technology for non-priority sectors, and restrictive clauses on exports. The gradual hardening of official policy towards foreign investment led to the announcement of a list of industries where further collaboration was banned and a separate list where technology inflow would be encouraged, Restrictions were also imposed on royalty and technical fees. In 1968, the Foreign Investment Board was set up and separate approval became necessary for all foreign collaboration cases. In this atmosphere of suspicion and uncertainty about the desirability of foreign investment, the declaration of 1/ N.K. Sengupta and A. Dasgupta, Government and Business in India. 2/ See Paragraph 45. 3/ See Attachment 2, (a), (b), and (c). -215- a 300% dividend and its repatriation by Colgate Palmolive 1/ triggered a furious debate in Parliament and outside on the need to regulate and control the activities of branches and subsidiaries of foreign companies. The con- troversy culminated with the passing of the third major piece of legislation - the Foreign Exchange Regulation Act (FERA) (1974). 40. Essentially FERA provided the Government with an opportunity to review the entire gamut of foreign investment activity in the country; to enforce certain changes in the corporate status of foreign companies to bring them within the ambit of control exercised through the Indian Companies Act; and to direct foreign investment into priority sectors. The major features of FERA were (a) the abolition of branches and their conversion into Indian Companies, 2/ (b) the requirement to obtain Reserve Bank (RBI) permission to carry on business in India in respect of foreign individuals and companies with more than 40% foreign share holding. 41. In issuing permissions to foreign individuals and companies to carry on business, the RBI, together with the Ministry of Finance, attempted to reduce foreign equity holdings in accordance to certain guidelines. The basic principle was to allow up to 40% of shares to be held by foreign parties, with the exception of those companies engaged in sophisticated technology or exports (which were allowed higher holding of 74%). 3/ In fact the forced dilution of foreign equity under FERA in respect of existing companies was first introduced in 1972, under general guidelines for dilution of equity in all licensing cases for expansion, manufacture of new products or new undertakings. As the dilution process was inherently fraught with the risk of losing management control altogether, few foreign majority companies dared to engage in fresh investment activity after 1972, preferring to con- solidate their operations. However, with the enactment of FERA it became mandatory for all foreign companies to dilute (to 40% or 74%, depending on the guidelines), as a condition for obtaining RBI permission to carry on business in India irrespective of whether they were engaged in expansion or not. However later in 1975 in the broader interests of export promotion an intermediate shareholding point of 51% was allowed to export-oriented units (undertakings with 60% of turnover from exports). (iii) Licensing Policy Decisions 42. As pointed out above, in the pre-1969 years there were no clear Government directives to licensing authorities on how to achieve specific 1/ A fully owned subsidiary of a U.S. company. 2/ Foreign banks and airlines were left out of FERA as it was decided that policy in these areas would be determined on a reciprocity basis. 31 Tea and coffee plantations were the only exceptions. -216- policy objectives. This vacuum was to be filled with two successi. policy announcements made in February 1970 and February 1973. These announcements are significant as they provided signals to the administrators of the control system. They defined favored categories such as the small-scale sector, the joint sector and cooperatives, which were to be given preferential treatment, as well as disfavored categories including large houses, dominant undertak- ings and foreign majority shareholding companies, which were subject to restrictions. 43. With the introduction of this framework, political and ideological considerations became for a time the dominant factor in industrial policy administration, and economic logic was given much less emphasis. Several cross-currents also started to emerge, as official policy announcements and press notes in practice restricted the grant of facilities for expansion in subsequent detailed notifications. Also, lists of activities barred to certain groups of investors tended to expand continuously. 1/ These various tendencies, further elaborated below, led to an increasingly complex regulatory framework, which proved difficult to change effectively when the deterioration in the international economy demanded more emphasis on efficiency in India's industrial sector. 44. The increased regulation of investment was exercised at two levels. Firstly, new investment activity by large houses, dominant undertakings and foreign majority companies, was confined to the narrow limits prescribed in a select list of key industries. Secondly, the expansion of existing undertak- ings was controlled with the imposition of a new set of regulations concerned with (a) reservation of industries for the small-scale sector, and (b) industries subject to special regulation. 45. The policy of restricting investment activity by large houses, 2/ dominant undertakings and foreign companies to a small list of key industries was first introduced in 1970 and has been continued to the present day. Initially the "core industries" of 1970 consisted only of 9 major industries, 1/ For instance, the investment limit for licensing was raised from Rs 2.5 million to Rs 10 million. Initially, undertakings not allowed to avail themselves of this facility only included large houses, dominant under- takings and undertakings using more than a specified amount of foreign exchange. By notification, however, industries subject to special regulations, to small-scale industry reservation, or belonging to the "core" list were also excluded, as were foreign majority companies. 2/ Initially for licensing purposes large houses were defined as undertak- ings with assets exceeding 35 crores (following the Dutt Committee recommendations). In 1973 however this limit was lowered to Rs 20 crores so as to fall in line with the definition of a large house in the MRTP Act. -217- (several of which were reserved for the public sector), covering fertilizers, pesticides, tractors and power tillers, a limited range of electronic components, and selected petro-chemical items. In February 1973 a more elaborate list of 19 industries was drawn up (popularly referred to as App. I List of 1973 Policy). After almost a decade the list was revised in 1982 and 5 additional items added. 1/ 46. The curbs on capacity expansion of existing undertakings were exer- cised through special notifications, issued to interpret policy guidelines. Thu the policy of reserving spheres of production for the SSI, initially intended to restrict entry, came to be used as a safeguard against the expan- sion of capacity of existing undertakings whose items of manufacture fell under SSI reservation. Similarly the list of industries subject to special regulation which was developed for other purposes, was used to prevent even non-NRTP/FERA companies from availing themselves of expansion facilities permitted under the increase in investment limits for industrial licensing or under existing schemes for diversification. Through yet other notifications exemption facilities (in respect of expansion as well as diversification) were denied to undertakings with assets over Rs 50 million even though they qualified otherwise in respect of SSI reservation, restrictions on items subject to special regulation, concentration of economic power and foreign ownership control. 47. The policy of encouraging the small-scale sector through reservation of spheres of production had been introduced in the late sixties. Initially it had Limited impact, as in 1969 the number of reserved items was only 47. It was raised to 59 items in February 1970, 177 items in February 1972 and to over 700 items in 1977-78, when the Janata Government came to power. Currently the reserved list has approximately 870 items. Some of these are generic groups and some are individual products. This list includes many engineering items, which were already produced by medium-sized undertakings (both FERA and others). These firms had also been fairly successful in developing export markets. The policy of reservation not only restricted new capacity installation in the medium- and large-scale sectors in respect of industries on the reserved list, but was used in a later stage to disallow capacity expansion under various schemes such as re-endorsement and regularization of capacity. 2/ 48. A special schedule of industries was introduced in the licensing policy of 1970 consisting of 6 items of mass consumption over which there were controls in respect of price and distribution. In 1973, this list was increased to eight items under the heading "Industries Subject to Special Regulation" (Schedule IV of 1973 policy). The February 1973 policy also 1/ See Attachment 2, (a), (b), and (c). 2/ See paras 53, 64. -218- introduced a second schedule of "other articles" (Schedule V) which consisted of 11 engineering items and two chemical items wbich were all using scarce imported or domestic raw materials. Almost 10 years later, in 1982, 1/ the list of "other articles" was increased from 13 to 66, and the two lists under Schedules IV and V were put together in one list of 78 items in April 1982. The Schedule IV list was further expanded in 1984 to include tractors, har- vester combines, automobiles, scooters, mopeds, etc. 2/ 49. Initially in the early seventies, the list of industries subject to special regulation was introduced to disallow substantial expansion and diversification facilities. As the number of industries which were subject to special regulation was relatively small, the List attracted little public attention. By the early eighties, however, it was no longer an innocuous measure. There had been a steady increase in the number of items in the list--now exceeding 80--and application of the list disqualified undertakings otherwise eligible for licensing concessions under facilities for re- endorsement of capacity. F. The Decade of Structural Adjustment, 1974-83 50. Prima facie significant revisions in licensing policy took place under the impetus of structural adjustment in the economy, following the oil price increases of 1973 and 1979. However, as already indicated above, some of the tendencies towards liberalization were offset by other measures. So, for instance, the policy changes introduced cautiously in the mid-seventies and somewhat more aggressively in 1980 and 1982, tended to be at least partly neutralized by the extension of other types of regulation such as increased reservation for SSI arid, more significantly, the growth of the list of industries subject to special regulations. Also, the rigid barriers to entry which had been enforced in the early seventies remain to this day an integral part of the control system, and the expansion of existing enterprises was similarly restricted. (i) Structural Adjustment to the First Oil Price Shock 51. The scope for policy change following the oil price shock of 1973 was narrow and circumscribed by historical circumstances. This as so because most of the regulations and rigidities in industrial licensing were of recent origin, and it was politically embarrassing to dismantle the regulatory structure as soon as it had been established, even though the economic cir- cumstances dictated the need for greater liberalization. The package of policy measures which was introduced in response to the crisis following the fist oil price increase was diverse and at times conflicting. The major 1/ January 25, 1982. 2/ See Attachment 3, (a) and (b). -219- weakness of the liberalization effort wan an underlying reluctance in the system to relinquish control. Except in a very limited sphere, policy con- tinued to be governed by considerations of size, dominance and ownership, and these were reflected in the strict eligibility conditions prescribed for availing of the relaxations. Another aspect of policy was the aggressive support to the modern small-scale sectQr. 52. The specific measures taken in this period related to: (a) diversification facilities in several engineering industries; (b) recognition of capacity on the basis of various considerations such as modernization, export performance, increased efficiency and rationalization of shifts; (c) automatic expansion of capacity in selected engineering industries, 1/ and establishing new capacity on the basis of 'commercial' utilization of results of Research and Development; (d) reduced scope of industrial licensing through increased delicensing of industries and higher investment limits for industrial licensing; (e) establishment of export processing zones; (f) accelerated SSI reservation. 53. Overall, the significance of the above measures was limited by the various requirements which had to be met, which sometimes conflicted with the avowed policy intentions. The permission to diversify within existing capacity was qualified by the condition that there should be no installation of machinery. In the case of recognition of excess capacity on accourt of modernization, the scope was restricted to non-SSI reserved items (in a period when SSI-reservation kept increasing) and subject to the condition there should be no increase in foreign exchange outflow. The latter condi- tion automatically ruled out import of knowhow or machinery under the modern- ization facility and thus tended to contribute to a perpetuation of tech- nological obsolescence. Similarly the policy of recognizing increased capacity on the basis of efficiency improvement (unlimited growth of 29 industries) was subject to SSI reservation, not applicable to MRTP/FERA companies and restricted by the condition that there should be no installa- tion of either domestic or imported machinery. In fact most measures for higher capacity utilization were merely a formality of recognizing existing excess capacity which had been surreptitiously installed over the previous 1/ See Attachment 4, Part B. -220- years, and to that extent, while still of same importance, contributed very little to additional output. At the same time excessive concern with growth of asset formation led to restrictions on the installation of machinery and on technology inflow. 54. The permitted capacity expansion measures were equally circumscribed by other conditions. The expansion of capacity under the policy of automatic growth in 15 engineering industries was limited to 25Z over the licensed capacity. Dominant undertakings were not eligible to use this concession. Other conditions were: (a) the article should not be reserved for the small- scale sector; (b) there should be no borrowing from the financial institutions; (c) there should be no restrictive clauses regarding exports in the foreign collaboration arguments; and (d) if the scheme of expansion involved the import of capital equipment, export obligations would be specified at the time of obtaining capital goods clearance. 55. It is not difficult to show that these exceptions must have sig- nificantly weakened the impact of the new policy. To start with, the SSI reservation condition ensured that many undertakings on the list of 15 engineering industries lost eligibility on account of the reservation policy (given that a significant number of reservation items are engineering products). Secondly, many engineering firms were also unable to use automatic growth on account of restrictive clauses in their collaboration agreements, which they had been forced to accept as a condition of technology transfer. 1/ Through the denial of borrowing facilities from the financial institutions and the restrictions imposed on import of capital equipment, the corporate sector also lost valuable opportunities to modernize and upgrade process technology during a period of output expansion. 56. Other policies that permitted capacity expansion were similarly qualified. Thus the policy permitting the commercial exploitation of in- house R&D facilities had limited application as MRTP and FERA companies,*the only categories likely to have supported any serious R&D programs, were kept within the narrow confines of the Appendix I industries. Of course, in most of the existing MRTP/FERA companies (operating in non-Appendix I industries due to historical reasons), in-house R&D programs were linked to existing lines of operation and not to industries listed in Appendix I. The policy to allow new capacity on basis of technology developed in approved laboratories was circumscribed by a series of conditions which stipulated that (a) the undertaking should not belong to a large house, or be dominant or have for- 1/ In actual practice, with the development of greater trust between the foreign partner and the domestic collaborator, these restrictions often came to be broadly interpreted in terms of market sharing, and even with restrictive clauses many such firms emerged as major exporters. This example shows the often counterproductive character of the licensing restrictions. -221- eign equity of over 40% and (b) the product to be manufactured should not be reserved for the small-scale sector, public sector or be subject to special regulations. 1/ 57. In the same vein policies to reduce the scope of industrial licensing were thwarted. Thus the policies relating to delicensing of 21 industries in 1975, and the raising of the investment limit from Rs 10 million to Rs 30 million in 1977/78, were restricted to exclude products reserved for SSI, and were accompanied by a ban on installation of machinery and a denial of facilities to MRTP/FERA companies. 58. Summarizing the above, it will be seen that although the declared intention behind the policy changes was to liberalize the regulatory environ- ment in which medium- and large-scale firms in the private sector could expand, in actual practice, only marginal improvements could take place due to the restrictive effect of various conditions governing the new policies. It would, therefore, appear that in the course of structural adjustment official policy in practice relied mainly on promoting output and investment in the public and joint sectors and, within the private sector, on coopera- tives and the organized small-scale sector. The small-scale sector in par- ticular was nurtured not only through increased reservation of production activity heavily emphasized by the Janata Covernment, but also through other policy decisions relating to size 2/ of investment and fiscal incentives based on turnover. (ii) The Post 1979 Years: Adjustment to the Second Shock 59. The set of policy measures that marked India's endeavor to overcome the second oil price shock of 1979 were enunciated in a Policy Statement issued in July 1980. For the first time since 1970, official policy formally conceded the "desirability" of allowing private sector undertakings to develop, although this statement of support was qualified by the pronounce- ment that such expansion of private sector interest should be in conformity with national priorities and targets. Official policy also called for improvement in operational efficiency of public sector undertakings and stressed the need to promote ancillarization and complementarity between small- and large-scale industry. 1/ This is another example of the use of the latter but to reduce the applicability of a policy decision. Earlier it had been introduced in 1970 and used for disallowing substantial expansion and diversification (see para 48). 2/ In 1975, the investment limit for determining a small-scale activity was raised from Rs 0.75 million to Rs 1 million and to Rs 1.5 million and for ancillaries. -222- 60. With some exceptions, the policy responses to the second shock foL- lowed much the same pattern that had been observed earlier. They were: (a) regularization of capacity in excess of licensed levels - confined to 34 key industries; (b) exclusion of production for exports in calculation of approved production on basis of licensed capacity; (c) extension of the automatic growth scheme to Appendix I industries and to 45 new industries; 1/ (d) re-endorsement of capacity scheme; (e) enlargement of the scope for new investment activity by MRTP/FERA companies through (i) revision of enlargement of Appendix I list of industries, 2/ (b) the announcement of nine industries of national importance in which investment would not require MRTP clearance, S/ (c) special incentives for investment in backward areas and zero industry districts, and (d) 100% export production units; and CM enhancement of the investment limits for exemption from industrial licensing. 61. If the policies in the adjustment to the second shock were roughly in the same direction as in the post-1973 phase, the application of policy also followed a similar pattern. Once again the purpose of liberalization was often thwarted by the imposition of restrictive conditions. Facilities for regularization of excess capacity in 34 key industries, and the policy of keeping production for exports outside regular approved capacity were subject to SSI reservation and the condition that there should be no installation of either domestic or imported machinery. Dominant undertakings were excluded (but non-dominant MRTP/FERA companies were permitted to apply under a special clearance procedure established through a Task Force). 62. A dynamic interpretation of the policy for promoting export produc- tion could have encouraged capacity expansion for exports. But the condi- tions specified above not only narrowed the scope of the new policy, but also reduced the scheme to one of regularizing existing excess capacity on the basis of export performance. Disallowing installation of machinery not only restricted capacity expansion within the narrow limits permitted under other 1/ Attachment 4, Part A and C. 2/ Attachment 2(c). 3/ Attachment 5. -223- policies pertaining to automatic growth and re-endorsement of capacity, but was also an impediment to technology upgrading-an obvious precondition to any long term serious program of promoting exports. The small-scale reserva- tion policy, introduced initially to erect barriers to the entry of large- scale firms into production of items which the small-scale could handle, was widely applied to curb capacity expansion of existing units, even for export purposes. 63. An effort at capacity expansion was made through a scheme of re- endorsement of capacity (April 1982). Under this policy capacity would be re-endorsed up to the level of actual production plus one-third when this was higher than licensed capacity plus 25%. In the very next year a firm once again became eligible for re-endorsement, provided its production plus one- third was once again higher than the new capacity after re-endorsement. The dynamic element of the re-endorsement scheme was the built-in mechanism for growth. Undertakings were permitted to install balancing equipment, and import necessary equipment under DCL, provided this did not lead to an expan- sion of capacity of over 25Z in any single year. In principle, the scheme permitted up to 25Z expansion of capacity every single year and was therefore much more attrActive than the automatic growth scheme, which limited capacity expansion to 25'. 64. Again, however, there were major exclusions in the new policy such as SSI reserved or specially regulated items, and the confinement of MRTP and FERA companies (other than dominant) to the Appendix I list of industries provided the scheme did not lead to dominance. MRTP/FERA companies, however, required a license for which simplified procedures were to be followed. These conditions were indeed restrictive, as is evident from the fact that over the past two-and-one-half years that the scheme has been in operation, most applications have been rejected either on grounds of dominance or because the item was reserved for SSI, or subject to special regulation. To date barely 300 cases have been approved for the re-endorsement facility. 65. Some expansion of capacity, however, was achieved through the exten- sion of the automatic growth scheme. 1/ Started in 1975 for only 15 engineering industries, it was extended in 1980 to all industries on the Appendix I list, and in 1982, 45 items were added. One important concession was the withdrawal of a clause (imposed in 1975) that all funds should be raised internally without recourse to the financial institutions. However, although the scope for automatic growth of capacity was extended, another item of legislation-an amendment of the MRTP Act in August 1982-sig- nificantly reduced its application. Prior to this amendment, non-dominant undertakings could expand substantially in the same line of operation, without having to obtain MRTP clearance. But with the withdrawal of this 11 Restricted to 25% growth in capacity over the licensed capacity. This increase could be implemented in stages or in a single operation. -224- facility (August 1982 Amendment), non-dominant MRTP firms eligible for licensing exemption for automatic growth are required to obtain MRTP clearance. (For other instances of tightening of MRTP regulations, see para 34 above). 66. MRTP and FERA companies were also given licensing concessions on the basis of plant location in backward or zero industry districts even for non-Appendix I industries. The rationale behind this policy was to attain a more equitable spread of industrialization, but it had two significant drawbacks. First, there was a likelihood that a very high percentage of new capacity would remain unimplemented due to inadequate infrastructure and other facilities in these districts, and, even if implemented, the policy would have succeeded in promoting more high cost units in the already ineffi- cient manufacturing sector. 67. Finally, measures to narrow the scope of licensing (by raising the investment limit from Rs 30 million to Rs 50 million) were also circumscribed by conditions regarding SSI reservation, reservation for the public sector, items subject to special regulation, limitations on the amount of foreign exchange to be used and restrictions on location in urban city limits. MRTP/FERA companies were excluded altogether. The major policies and the conditions circumscribing eligibility are presented in Table 1 below. 68. In the period of adjustment to the second shock significant revisions were effected in the legal apparatus through Amendments of the MRTP and IDR Acts. As pointed out in para 34 above, the first Amendment of the MRTP Act (1982) essentially withdrew an existing facility allowing to non-dominant MRTP firms to expand substantially in the same line of activity without obtaining MRTP clearance. As a concession the Amendment did allow MRTP exemption in nine areas. To what extent this policy will encourage invest- ment remains to be seen. Much depends on the ability to generate internal resources, and mobilize management and technical expertise for this purpose. As for the Amendment of 1984, there can be no doubt that with the revised definition of dominance and inter-connection, the scope of the MRTP Act has been visibly widened. 69. There has also been an Amendment to the IDR Act of 1951 which con- cerns SSI product reservation. Although the IDR Act 1951 had a provision for product reservation on the basis of size and scale of investment, until the August 1984 Amendment there was no legal basis for the notifications which pegged production of medium and large firms to the average production level achieved in the three years immediately prior to the imposition of the reservation. Frequently, the permitted production was below the licensed capacity, and sometimes even well below balanced line capacity. The Act was amended in view of a case before the Supreme Court in which two manufacturers challenged the validity of the notifications. Their contention was that the Government could not restrict production through arbitrary notification since they had been allowed a certain licensed capacity through an industrial license under the IDR Act. As amended, the IDR Act upholds the right of the -225- Government to issue such notifications. As a concession, however, manufac- turers may be allowed to increase production up to the level determined by balanced line capacity, provided 75% of the additional production is exported. 70. Reviewing the policy liberalization measures initiated in the deca4e of structural adjustment (1974-83), it would appear that policy implemente- tion fell sadly short of intent and, barring a few exceptions, relaxation measures were clouded with eligibility conditions which considerably circum- scribed the liberalization measures. In essence, the rigidities introduced in the early seventies remained in the system due to continued obsession at the implementation level with considerations regarding size, dominance and ownership of assets. In addition, newer instruments of control have been expanded such as SSI reservations, industries subject to special regulation and policy regarding installation of machinery. At the same time, the legal apparatus was tightened, with far reaching consequences on the corporate sector. Taking these various strands of policy together, it is doubtful whether on balance the period can in fact be characterized as one of gradual liberalization of industrial controls. -226- Table VII.1: INDUSTRIAL POLICY LIBERALIZATION MEASURES AND CONDITIVAS CIRCUMSCRIBING ELIGIBILITY Conditions Policies in Response to First Shock A B C D E F G H I Automatic growth in 15 eng. inds. (25!) X X 3/ X I Capacity recognition due to modernization I Ill X1/ X Unlimited growth of 29 industries X I I I X Commercial utilisation of in-house R&D 2/ 2/ Commercial utilisation of R&D in Lbas I X I I De-Licensing of 21 industries I X X X X Higher limits for licensing I I I Policies in Response to Second Shock Automatic growth in 79 industries I 4/ X 3/ Regularization of capacity - 34 industries X ICI X1/ l X Production of exports X X X X Re-endorsement scheme X X X1/ X Higher limits for licensing X I I X 5/ 100% export production units Zero industry 11 Subject to Task Force clearance. 11 Confined to Appendix I industries. 3/ Subject to export obligation. 4M HRTP clearance required under recent Amendment. 5/ Subject to foreign exchange limits of Rs 40 lakhs or 151 of turnover. A = SSI reservation (see note 1) below. B = Industries subject to Special Regulation (see note 2) below. C - MRTP/FERA (non-dominant). D = Dominant undertakings. E = Foreign exchange. F = Imports of machivery and equipment. G - Installation of domestic machinery. H = Borrowing from financial institutions I - Restrictions in collaborations. Notes: (I) In the period 1973-79, the number of items under SSI reservation increased from 177 to over 800 items. At present, 874 items are under SSI recervation. (2) In the period 1979-84, the number of items under special regulations and capacity restrictions increased from 21 items to about 80 items. -226-A G. Recent Policy Trends: The Post-1983 Period 71. On the eve of the VII Plan, there appears to be a realization that despite major liberalization measures in the decade of structural adjustment to the oil shocks, policy constraints have inhibited output growth and investment. In contrast to the earlier "broad brush" approach, the new policy is to focus on specific problems of selected critical sectors and evolve a package of policy measures narrowly applicable to those sectors alone. Given the ineffectiveness of past liberalization efforts, this sec- toral outlook has at least the advantage that specific irritants constraining output growth and capacity utilization are reduced. 72. Some of the important develo;ments of recent months include (a) the opening up of telecommunication equipment manufacturing to the private sector; (b) the broad banding of licenses in automobiles, machinery and paper; (c) the withdrawal of restrictions on the production of consumer electronics in the large-scale private sector; (d) the decision to allow foreign equity companies to manufacture computers; and (e) the removal of licensing ceilings on production of computers in the private sector outside the small-scale sector. 73. The decision to allow private sector participation in telecommunica- tion equipment manufacturing is a pragmatic move, prompted by the severe supply bottlenecks arising from the inability of the public sector units to keep pace with the sector's growing requirements. It is particularly bold, as it involves a Schedule A industry of IBR of 1956 1/ and demonstrates the flexibility of the policy framework to adjust to specific needs. The policy announcement stipulated that in the manufacture of switching and transmission equipm2nt, joint participation with State sector units would be necessary. No condition was stipulated for terminal equipment manufacturing. 74. In electronics there are some unresolved issues. The decision to permit large-scale manufacturing was inspired by the broader policy decision to widen the production base of consumer electronics to support the domestic manufacture of integrated circuits. However, policy for the manufacture of components continues to show bias against the large-scale sector, in par- ticular foreign equity companies. In computers, some of these biases have been significantly corrected in the recent policy announcement. But the reservation of production of large computer systems for the public sector, and the price preference to that sector indicates that there is to be no significant move away from the pro-public bias which has characterized the growth of the industry to date. 1/ See Attachment 1. -227- 75. One of the most important recent policy decisions which help the removal of the counter-productive licensing regulations, relates to the broad banding of products for industrial licensing in place of the narrow, specific product licensing which was introduced in the early sixties. The rationale for the new approach is that, given the common design and production facilities for many aggregates of products, flexibility in product mix would lead to fuller capacity utilization and higher output growth. The new policy would also permit manufacturers to follow market trends more effectively, changing products in response to shifts in demand. Overall licensed capacity would remain unchanged and separate clearances would be required for foreign collaboration where necessary. 76. Broad-banding strategy was first introduced in the machine tools sector almost a year back, to alleviate the problems of capacity under- utilization. Its success lead to its adoption in the automobile sector, followed in quick succession by non-electrical machinery for the chemical, petrochemical and pharmaceutical industries and paper production. In automobiles, two broad categories were introduced: two and three wheelers, and on road automobiles having four or more wheels. Under the new policy, manufacturers holding industrial licenses to manufacture specific items such as passenger cars, jeeps, commercial vehicles, scooters and mopeds can freely convert their individual licenses for manufacture of specific items in any of the two relevant groups. Thus manufacturers of commercial vehicles can move into the production of passenger cars and vice versa. Similarly manufac- turers of scooters can switch to the production of motorcycles. 77. In the paper industry, manufacturers would have the freedom to manufacture any variety of paper, paper grade and pulp, and paper board/straw board, excepting those reserved for the small-scale sector. In the produc- tion of machinery for chemicals, pharmaceuticals, petrochemicals and fer- tilizer industries, 10 broad categories have been announced. Under this classification, pressure vessels/reactors/columns/towers/storage tanks, etc., all come under one group. A similar group has been effected for heat trans- fer systems, filters and filtration systems, mixing and homogenizing systems, capsule and tablet-making machines, concentrating and drying systems, water and waste water treatment plants, etc. 78. These decisions to broad band licensing remove some of the irrationalities that had crept into the licensing system. They are to be welcomed as they should lead to improvement in capacity utilization, in the short run, with some balancing equipment. In the long run, this policy could, in conjunction with a liberal technology policy, lead to significant improvements in the overall efficiency of manufacturing. But it must be pointed out that a mere beginning has been made. Broadbanding should be carried logically forward from machinery for chemicals, petrochemicals, pharmaceuticals and fertilizers to the industry itself, so that manufacturers have the freedom to change the composition of ingredients within a specified product group. -228- 79. The process of liberalization during 1984/85 culminated with the policy decisions the new Government announced on March 15, at the time of the presentation of the Budget for 1985/86. The most significant element was the decision to raise the asset limit for large houses from Rs 200 million to Ru 1,000 million. As discussed elsewhere, 1/ this increase is consistent with the growth of the economy since 1969, when the previous limit of Rs 200 million was established. Logically it can be expected that raising the limit will reduce the coverage of the NRTP Act. It has to be remembered however that the revised definition of interconnection in the 1984 Amendment of the MRTP Act will operate in a counter direction. Other policy decisions were: raising the asset limitn for small-stale and ancillaries to Rs 3.50 million and Rs 4.50 million respectively, and the delicensing of 25 industries. 80. There can be no doubt that there is some element of liberalization through delicensing. But too much should not be expected of this measure. As many as 16 of the industries delicensed had in fact already been outside licensing requirements since November 1975. Secondly, of the remaining industries, several are largely reserved for the small-scale sector (e.g. electronic components, auto ancillaries, cycle parts, plastic moulded goods, ceramics such as tiles, chinaware etc.), a few included in licensing only recently (pressure cooker, cutlery, steel furniture, fuel efficient stoves etc.), and yet others are industries in which a fairly liberal licensing policy exists (equipment for exploitation of alternative sources of energy, steam turbines and power distribution, and transmission equipment). The list of industries delicensed includes, however, some items which are subject to special regulation and capacity constraints. It is in these industries that a positive impact of the liberalization measure can be expected. H. Some Concluding Observations (M) Impact of Licensing Policy on the Structure of Manufacturing 81. In the discussion above, we have traced the evolution of licensing policy changes during the period 1951-85. It will be evident that until the mid-sizties the licensing system was seldom perceived as a constraint on growth of capacity and output. Indeed the administration of licensing was fairly liberal, and there was some abuse of the system by the private sector to strengthen monopolistic situations. However, with the changes in the legislative framework following the enactment of MRTP (1969) and FERA (1974), and general restrictions introduced in the policy decisions of February 1970 as modified in February 1973, the two major constraints of licensing systems were (a) barriers to entry, through SSI reservation and discrimination in investment policy implicit in Appendix I list of industries; and (b) restrictions on capacity and output growth through ceilings on licensed 1/ See Attachment 6. -229- capacities and, where these were liberalized, through the application of other criteria such as SSI reservation, industries subject to special regulation, reservation of production for public sector and dominance. Further, the pursuit of certain objectives, such as regional spread of industries, the diffusion of the entrepreneurial base, progressive indigenization, joint product Licensing, influenced the structure of manufac- turing industry. PrimariLy they led to the establishment of high cost units in remote areas, uneconomic scales of production and excess capacity arising from mismatching of capacities, or overestimation of market demand by the planning authorities. 82. These tendencies were further strengthened in the post-1970 period due to increased SST reservation and curbs on expansion of capacity of mdium-sized firms producing items subject to reservation. The large reser- vation list and its growing size is a matter of concern on two counts. First, the SSI reservation itself is a major barrier to entry, limiting capacity and output growth in the sector. Second and more importantly, the application of SSI reservation list to curtail output of existing firms outside the sector, and the denial of opportunity to avail of econcmies of scale, modernize or upgrade technology, allowed under broader policy relaxa- tions are factors which adversely affect the competitiveness of Indian industry and contribute to slow growth. I1 83. While SSI reservation influenced output growth, another list consist- ing of industries subject to special regulation also came to be used to curtail liberation measures. Initially, this list consisted of a handful of consumer items which were subject to price control-some of which depended on scarce raw materials, imported and domestic. Subsequently, this list was expanded to about 80 items also covering induatries in which excess capacity existed. With general price decontrol, import liberalization and improved domestic availability, there seems to be little justification for this list. In any case, the firms engaged in the production of items enumerated in this list have to obtain separate clearances for imports and other allocations, independent of the licensing system. As for items subject to capacity constraints, an alternative approach could be a ban on the entry by new firms instead of restricting the growth of the more enterprising existing manufacturers. The use of this list in the re-endorsement scheme has been particularly restrictive. 84. At the same time, concern with the industrialization of backward districts prompted a policy of encouraging large investments in remote dis- tricts with inadequate infrastructural facilities. The requirement to go to backward districts was frequently used as a condition for the granting of an industrial license to MRTP companies, even in respect of industries on the 1/ A recent Bank study has demonstrated this for light Engineering industry - India: Light Industrial Export Development and Finance 1983. -230- Appendix I list. It remains to be seen to what extent these licenses are actually implemented, but there can be no doubt that their implementation will lead to new high cost units being set up in the eighties. 85. Another policy dimension of the post 1970s was the curb on installa- tion of machinery and equipment (whether imported or indigenous) with respect to particular licensing liberalization measures. 1/ No doubt the intention was to contain the growth of asset formation in the medium- and large-scale private corporate sector, but to some extent the technological obsolescence that is currently evident in the manufacturing sector can be traced to such conditions being imposed while permitting unlimited growth, expansion or regularization of capacity, or recognizing production for exports as being outside regular capacity. However, a redeeming aspect has been the general liberalization of imports of capital gooda since the early eighties. 86. Excessive concern with size, dominance and concentration of economic power typically characterized the post-1970s policies. It would be relevant to point out that while the investment limits for industrial licensing and the small-scale sector were systematically enhanced to offset inflation, no such allowance has been made in respect of the size limits for dominance and large houses for the past 15 years. 2/ 87. Dominant undertakings are particularly constrained. Most of the dominant undertakings were set up in the import substitution period, when the domestic market was fairly small. In fact, a number of firms commenced manufacturing from a position of dominance. Over the course of several years, these firms took a significant lead in establishing export outlets, particularly in engineering products. However, with SSI reservation, output growth was severely constrained. Further, with the amendments to the MRTP Act, the number of dominant undertakings has increased. In part, this would be due to a change in the definition of dominance (from one-third to one- fourth of output), and in part to the introduction of a second alternative criterion, which the firm would meet by accounting for one-fourth or more of the licensed capacity. 80. The implications of this are far-reaching as it will lead to per- petuation of dominant status for firms engaged in items reserved for the small-acale sector. This is so because there is a virtual freeze on licenjed capacity with the imposition of the SSI reservation. Previously, when market 11 See Table VII.1. 2/ Between 1969-83, the investment limits for industrial licensing was increased from Rs 2.5 million to Rs 10 million in 1970, to Rs 30 million in 1978 and Rs 50 million in 1983. Similarly, for the small-scale sector the limit was raised from Rs 0.75 million to Rs 2.0 million in this period, and Rs 3.5 million in 1985 (see Attachment 4). -231- share waa the sole criterion for establishing dominance, there was always scope for deregistration with increased share of output originating in the small-scale sector. For non-SSI reserved items, however, an inequity in the system is that a new firm with fixed assets below Re 50 million can commence production without an industrial license, while an existing dominant firm with assets well below the licensing limit but with assets over Rs 10 million would have to obtain MRTP clearance even for substantial expansion. 89. Another aspect of barrier to entry is seen in the policy of confining dominant undertakings, large houses and 40% foreign equity companies to a narrow select capital intensive sector, which a1so involves high technology. This sector is defined in the Appendix I list of industries of the 1973 licensing policy decision. The application of this list has several implications. First, it impliea a discriminatory approach in investment policy, within the private sector, denying as it does the right to entry in sectors outside Appendix I where there may be supply constraints. This is particularly harsh for small-sized dominant undertakings and foreign equity companies with assets below the licensed limit. Besides, the application of Appendix I policy assumes that such companies have the necessary management and technical skills to enter fields where they have no previous experience-- a questionable assumption. 90. Preferential treatment to the public and joint sector, and excessive policy concern with dominance, concentration of economic power, and foreign ownership in the post-seventies period also explains the shrinking role of the private corporate sector. In the years 1973/74-1981/82, for which data are available, the share of the private sector in fixed capital stock declined from 62% in 1974/75 to 48% in 1981/82. In the same period, the share of the public sector recorded a sharp increase from 28% in the earlier year to 39% in the latter. (ii) Agenda for Change 91. We have discussed above some of the specific constraints on capacity output growth and efficiency which are traceable to licensing policy. The constraining element is not licensing per se, but the multiplicity of objectives, frequently contradictory, to be achieved through licensing. In an agenda for change, the first steps must necessarily be the simplification of procedures, and there are indications that the Government is serious in streamlining procedures through a "single window" clearance. The subsequent emphasis must focus on the removal of the constraints arising from the finer print in policy implementation and on reform of the regulatory framework itself. 92. The major constraints in policy implementation are barriers to entry and restrictions on capacity and output growth. These constraints could be easily addressed as they do not call for any change in the legislative framework. On oarriers to entry, the SSI reservation list should be rationalized, and a policy adopted to encourage the movement of firms out of -232- the small-scale sector, instead of providing continuous protection by raising the investment limits for small-scale undertakings. Thare is also a case for revising the Appendix I list of industries, which is essantially dis- criminatory in terms of investment policy. Lastly, capacity ceilings on large segmenLa, including SSI reservation products, domiaant firms and industries subject to special regulations should be revieved in the greater interests of sustaining industrial growth. 93. The more difficult and controversial aspects of policy change is in the area of the legal framework. The need for changt Lies not in the policy framework enunciated in the Industrial Policy Resolution of 1956, which has proved to be more flexible than was realized in the past, but in the revision of investment limits for dominance and concentration of economic power, in line with growth of prices and real growth in the economy since 1969, and in the definitions of dominance and interconnection introduced in the recent amendments to the HRTP Act. (iii) The Statistical Base: Its Inadequacies and Suggestions for Improve- ments. 94. In the above discission, we have traced some of the malaise of the manufacturing sector to policies initiated in the early years of planning, and to others of more recent origin. We were unable to quantify the impact of policy measures due to existing inadequacies in industrial statistics in general and licensing statistics in particular. The only information avail- able from the Secretariat of Industrial Approvals is on the number of licen- see approved in a given year, possibly wit a statistical break-down for new licenses and COB. 1/ Some limited classification, again only on basis of numbers of licenses approved, is maintained for backward districts and KRTP and FERA companies. There appears to be no published data on investments approved, in any single year, nor on the progress in imp'ementation. 95. Auother weakness is that there is no periodic review of the administration of licenses, including a study of applications received, applications rejected and reasons for rejection, and the implementation of the approved licenses, without wLich it is virtually imp isible to assess, except in very general term, the impact of specific policy measures. It ia not enough to know that 300 cases were approved for re-er5orsement. Further information is Tequired on how many undertakings applied in the first place in response to the scheme, and an analysis of the rejections on the basis of various considerarions might throw some light on how policies are administered. In fact, a review of the administration of the licensing policy on the lines of the Dutt Committee report 15 years earlier would throw considerable light on the functioning of the system. 1/ Carrying on Business Licease. -233- 96. Finally, we would like to draw the attention of the reader to some of the shortcomings of the statistical information on the factory sector pub- lished in the Annual Survey of Industries. Basically the presentation of data is such that no clear profile emerges of the corporate sector. There is no information on the relative shares of the constituents of the medium- and large-scale sector (over Rs 2.0 million) 1/ including the unlicensed sector (up to Rs 50 million), the middle sector tRs 50-200 million) and the large- scale sector (over Rs 200 million). 2/ Nor are the contributions of dominant undertakings and FERA companies (cutEing across size classification) in the principal aggregates known, or for that matter the weight in the index of industrial production of industry groups which are under SSI reservaticn or subject to special regulation. These lacunae also provide some of the direc- tions in which the statistical base could be strengthened to be a more useful tool for policy management. 1/ In the Budget of 1985 the investment limits for small-scale undertak- ings and ancillaries were raised to Rs 3.5 million and Rs 4.5 million respectively. 2/ See Attachment 7. -234- Attachment 1 List of Industries in Schedule A &B Industrial Policy Resolution 1956 SCHEDULE 'A' (1) Arms and ammunition and allied items of defense equipment. (2) Atomic energy (3) Iron and steel (4) Heavy castings and forgings of iron and steel (5) Heavy plant and machinery required for iron and steel production, for mining, for machine tools manufacture and for such other basic industries as may be specified by the Central Government (6) Heavy Electrical plant including large hydraulic and steam turbines (7) Coal and lignite (8) Mineral oils (9) Mining of iron ore, manganese ore, chrome ore, gypsum, sulphur, gold and diamond (10) Mining and processing of copper, lead, zinc, tin, molybdenum and wolfram (11) Minerals specified in the Schedule to the Atomic Energy (Control of Production and Use) Order, 1953 (12) Aircraft (13) Railway transport (14) Air transport (15) Ship building (16) Telephones and telephone cable, telegraph ad wireless apparatus (excluding radio receiving sets) (17) Generation and distribution of Electricity -235- SCHEDULE 'B' (1) All other minerals except "minor minerals" as defined in Section 3 of the Minerals Concession Rules, 1949 (2) Aluminum and other non-ferrous metals not included in Schedule 'A' (3) Machine Tools (4) Ferro-alloys and tools steels (5) Basic and intermediate products required by chemical industries such as the manufacture of drugs, dyestuffs and plastics (6) Antibiotics and other essential drugs (7) Fertilizers (8) Synthetic rubber (9) Carbonization of coal (10) Chemical Pulp (11) Road Transport (12) Sea Transport -236- Attachment 2(a) List of "Core" Industries (February 1970 Policy) 1. Agricultural inputs: (a) Fertilizers (i) Nitrogenous (ii) Phosphatic (b) Pesticides (basic chemicals only) (c) Tractors and power tillers (d) Rock-Phosphate and pyrites 2. Iron & Steel (a) Iron ore (b) Pig iron and steel (c) Alloy and special steels 3. Non-ferrous Metals: 4. Petroleum: (a) Oil exploration and production (b) Petroleum refining (c) Selected petrochemicals: (i) Integrated petro-chemicals complexes (ii) D.M.T. (iii) Caprolactum (iv) Acrylonitrile (v) Synthetic rubber 5. Coking coal 6. Heavy industrial machinery (to be specified) 7. Shipbuilding and dredgers 8. Newsprint 9. Electronics (selected components, testing and control equipment wireless and micro-wave equipment) -237- Attachment 2(b) List of "Appendix I" Industries (February 1973 Policy) 1. Metallurgical industries (1) Ferro alloys (2) Steel castings and forgings (3) Special steels (4) Non-ferrous metals and their alloys 2. Boilers and Steam Generating Plants 3. Prime Movers (other than electrical generators) (1) Industrial turbines (2) Internal combustion engines 4. Electrical equipment (1) Equipment for transmission and distribution of electricity (2) Electric motors (3) Electric furnaces (4) X-ray equipment (5) Electronic components and equipment 5. Transportation (1) Mechanized sailing vessels up to 1,000 DUT (2) Ship ancillaries (3) Commercial vehicles 6. Industrial machinery 7. Machine tools 8. Agricultural machinery Tractors and power tillers 9. Earth moving machinery 10. Industrial instruments, indicating, recording and regulating devices for pressure, temperature, rate of flow, weights, levels and the like 11. Scientific instruments -238- 12. Nitrogenous and phosphatic fertilizers falling under '(1) Inorganic fertilizers' under '18, Fertilizers' in the First Schedule to the I (D&R) Act 1951 13. Chemicals (other than Fertilizers) (1) Inorganic heavy chemicals (2) Organic heavy chemicals (3) Fine chemicals, including photographic chemicals (3) Synthetic resins and plastics (5) Synthetic rubbers (6) Man-made fibres (7) Industrial explosives (8) Insecticides, fungicides, weedicides and the like (9) Synthetic detergents (10) Miscellaneous chemicals (for industrial use only) 14. Drugs and pharmaceuticals 15. Paper and pulp including paper products 16. Automobile tires and tubes 17. Plate glass 18. Ceramics (1) Refractories (2) Furnace lining bricks - acidic, basic and neutral 19. Cement products (1) Portland cement (2) Asbestos cement -239- Attachment 2(c) Revised List of Appendix I of 1973 Policy (as of October 1984) SCHEDULE 1. Metallurgical Industries 1. Ferro alloys 2. Automotive castings, SG iron castings, steel castings and steel forgings 3. Non-ferrous metals and their alloys, including aluminum foils 4. Sponge iron and pelletization 2. Boilers and Steam Generating Plants 3. Prive Movers (Other than Electrical Generators) 1. Industrial turbines 2. Internal combustion engines 3. Alternative energy system like solar, wind, etc. & equipments therefor 4. Gas/hydro/steam turbines for 20 MW to 60 MW 4. Electrical Equipment 1. Equipment for transmission and distribution of electricity including power and distribution transformers, power relays, BT-switch gear, synchronous condensers 2. Electrical motors 3. Electrical furnaces including industrial furnaces 4. X-ray equipment 5. Electronic components and equipment 6. Component wires for manufactures of lead-in-wires 7. Hydro/steam/gas generators from 20 MNW to 60 MW 5. Transportation 1. Mechanized sailing vessels up to 10,000 DWT including fishing trawlers 2. Ship ancillaries 3. (1) Commercial vehicles, public transport vehicles including automotive commercial three-wheels jeep type vehicles, industrial locomotives (2) Personal transport vehicles (i) Passenger cars (ii) Automotive two-wheelers and three-wheelers, regarding two-wheelers, only expansion of existing units, subject to an export obligation of 25% on additional capacity. -240- (3) Specialized automotive components, such as pistons and piston rings, fuel injection equipment; auto-electricals, such as starter motors, generators, spark plugs, rear axle assembly, brake and clutch assembly, tire/tube valves, wheels for automobiles and bimetal bearings. 6. Industrial Machinery Industrial machinery including specified equipment 1. High performance and high fidelity industrial valves as may be specified by the Ministry of Industry 2. Centralized lubrication systems 3. Gears, gear boxes and couplings 4. Rolls for paper mills, rolls for rolling mills 5. Population control equipment 6. Process equipment for utilization or recycling of wastes 7. (1) Machine tools, including controls and accessories (2) Jigs, fixtures, tools and dies of specified types and crossland tooling (3) Engineering production aids such as cutting and forming tools, pattern and dies and mining tools 8. Agricultural Machinery Tractors 9. Earth Moving Machinery Earth Moving machinery and construction machinery and components thereof 10. Industrial Instruments Indicating, recording and regulating devices for pressure, temperature, rate of flow, weights, levels and the like 11. Scientific and Electromedical Instruments and Laboratory Equipment 12. Nitrogenous & Phosphatic Fertilizers falling under: (1) Inorganic fertilizers under '18-Fertilizers' in the First Schedule to the I (D&R) Act, 1951 13. Chemicals (other than fertilizers) 1. Heavy organic chemicals including petro-chemicals 2. Heavy inorganic chemicals 3. Organic fine chemicals 4. Synthetic resins and plastics 5. Man-made fibres 6. Synthetic rubber 7. Industrial explosives 8. Technical grade insecticides, fungicides, weedicides and the like -241- 9. Synthetic detergents 10. Miscellaneous chemicals (for industrial use only) including: 1. Catalysts and Catalyst supports 2. Photographic chemicals 3. Rubber chemicals 4. Polyols 5. Isocyanate3, urethanes, etc. 6. Speciality chemicals for enhanced oil recovery 7. Heating fluids 8. Coal tar distillation and products therefrom 9. Tonnage plants for the manufacture of iadustrial gases 10. High attitude breathing oxygen medical oxygen 11. Nitrous oxide 12. Refrigerant gases like liquid nitrogen, carbon dioxide, etc. in large volumes 13. Argon and other rare gases 14. Alkali/acid resisting cement compound 15. Leather chemicals and auxiliaries 14. Drugs and Pharmaceuticals For FERA drug companies. (a) Drug intermediates from the basic stage for production of High technology bulk drugs; (b) High technology bulk drugs from basic stages and formulations based thereon with an overall ratio of bulk drug consumption (from own manufacture) to formulations from all sources of 1.5. For non-FERA companies All bulk drugs and formulations with an overall ratio of 1:10 between the value of production of bulk drugs and of formulations. 15. (1) Paper and pulp including paper products (2) Industrial laminates 16. (1) Automobile tires and tubes, including automobile tire tube values (2) Rubberized heavy duty industrial beltings of all types (3) Rubberized conveyor beltings (4) Rubber reinforced and lined fire fighting hose pipes 17. Plate Glass 1. Float glass 2. Toughened glass insulators 3 Glass fibres of all types -242- 18. Ceramics 1. Refractories 2. Furnace lining bricks-acidic, basic and neutral 3. Ceramic fibres 19. Cement Products 1. Portland cement 2. Gypsum boards, wall boards and the like 20. High Technology Reproduction and Multiplication Equipment 21. Carbon and Carbon Products 1. Graphite electrodes and anodes 2. Impervious graphite blocks and sheets 22. Pretensioned High Pressure RCC Pipes 23. Rubber Machinery 24. Printing Machinery 1. Web-Fed high speed offset rotary printing machines having output 6f 30,000 or more impressions per hour 2. Photo composing/type setting machines 3. Multi-color sheet-fed offset printing machines of sizes 18" x 25" and above 4. High speed Rotogravure printing machines having output of 30,000 or more impressions per hour 25. Soya Products 1. Soya Texturized Proteins 2. Soya Protein Isolates 3. Soya Protein Concentrates 4. Other Specialized Products of Soya Bean 5. Winterized and Deodorized Refined Soya Bean Oil -243- Attachment 3(a) List of Industries Requiring Special Regulation (February 1973 Policy) 1. Coal falling under '(1). Coal', lignite, coke and their derivatives under the heading "2. Fuels". 2. Textile, falling under the heading "23. Textiles (including those dyed, printed or otherwise processed) manufactured, produced on powerlooms". 3. Milk foods falling under "(2) Milk foods"; Malted foods falling under "(3) Malted Foods" and Roller flour milling falling under "(4) Flour" under the heading "27. Food Processing Industries". 4. (a) Oil seed crushing, falling under "(1) Vegetable oils including solvent extracted oils" and (b) Vanaspati falling under "(2) Vanaspati" under the heading "28. Vegetable Oils and Vanaspati". 5. Leather falling under the heading "31. Leather, Leather Goods and Pickers". 6. Matches falling under "(3) Matches" under the heading "36. Timber Products". 7. Beer falling under "(2) Other products of fermentation industries under the heading "26 - Fermentation Industries". (This item added vide Notification No. 122(E)/IDRA/74/3 dated 26 February 1974). 8. Distillation or brewing of alcoholic drinks (Press Note No. D(187)/L.P./75 of November 19, 1975). (Other Articles) 1. All qualities of steel manufactured from electric furnaces based on scrap falling under (I) Iron and Steel (Metal) and (6) Special Steel under the heading: "I. METALLURGICAL INDUSTRIES: A. Ferrous". 2. Iron and steel, pipes and tubes and stainless tubes falling under (5) Iron and Steel Pipes under the heading "I. METALLURGICAL INDUSTRIES: A. Ferrous". 3. Bright bars 4. Tin containers and metal containers -244- 5. Drums and barrels 6. Wires of Mild steel, special steel and alloy steel-coated and uncoated 7. Re-rolling of steel including manufacture of hot rolled bars/rod. and sections using billets or rerollable scrap as raw material and also cold rolled biliets and box strapping. The above items 3 to 7 fall under (7) Other products of iron and steel under the heading "I. METALLURCIAL INDUSTRIES: A Ferrous". 8. Non-ferrous semis alloys, flat products and extrusions excluding aluminum semis falling under the heading "I. METALLURCIAL INDUSTRIES: B. Non-ferrous". 9. Plastic processed goods falling under "(1) Plastic moulded goods" under the heading. "12. MISCELLANEOUS MECHANICAL AND ENCINEERINC INDUSTRIES". 10. Industrial gases falling under "(14) Miscellaneous Chemicals" under the beading," "19. CHEMICALS (OTHER THAN PERTILIZFRS)". 11. Steel forgings falling under (3) Iron and steel castings and forgings under the heading "1. METALLURGICAL INDUSTRIES". 12. AAC/ACSR. Conductors falling under '(6) Electrical Cables and Wires' under the heading "5. ELECTRICAL EQUIPMENT". 13. Formaldehyde falling under "(2) Organic Heavy Chemicals" under the heading "19. CHEMICALS (OTHER THAN FERTILIZERS)". -245- Attachment 3(b) (As of October 1984) 1. Coal falling under "(1) Coal, ligniLe, coke and their derivatives under the heading "2 Fuels". 2. Textile, falling under the heading "23, Textile (including rhose dyed, printed or otherwise processed, manufactured, produced or processed on powerloome". 3. Hilk foods falling under '(2) Milk foods'; Malted foods falling under '(3) Malted Foods' and Roller flour milling falling under '(4) Flour' under the heading "27, Food Processing Industries". 4. (a) Oil seed crushing, falling under '(1) Vegetable oils includ- ing solvent extracted oils" and (b) Vanaspati falling under '(2) Vanaspcti' under the heading "28, Vegetable Oils and Vanspati". 5. Leather falling under the heading "31, Leather, Leather Coods and Pickers". 6. Matches falling under '(3) Matches' under the heading "36, Timber products". 7. Distillation or brewing of alcoholic drinks falling under the heading "26-Fermentation Industries". 8. Hot-rolling of semis, bars, Wire rods and structural sections of steel. 9. All quelities of steel manufactured from electric furnaces based on scrap, falling under '(1) Iron and Steel (Metal)' and '(6) Special Steel' under the heading; "1. METALLURCICtL INDUSTRIES: A. Ferrous". 10. Iron and Steel pipes and tubes and stainless tubes falling under '(5) Iron and Steel Pipes' under the heading; "1. 'METALLURGICAL INDUSTRIES: A. Ferrous". 11. Bright Bars. 12. Tin containers and metal containers. 13. Drums and barrels. 14. Wires of mild steel, special steel and alloys steel coated and uncoated. 15. Cold and hot rolled strips, sheets and plates of all categories of steel including box strappings. The above items 11 to 15 fall under '(7) Other products of 'Iron and Steel' under the heading "1. METALLURGICAL INDUSTRIES: A Ferrous". 16. Non-ferrous semis alloys. Flat products and extrusionq falling under the heading "1. METALLURCICAL INDUSTRIES. B. Non-Ferrous". 17. ACC/ACSR Conductors falling under '(6) Electrical Cables and Wires' under the heading "5. ELECTRICAL EQUIPMENT." 18. Cold Rolled formed section. 19. Hamilton poles. 20. Tobular poles. 21. Steel Structurals. -246- 22. Sheet Metal Components. 23. T.V. Receivers. 24. Sheet, figured and wired gLass. 25. Plywood, Decorative Veneers, Block Boards and Fl%sh Doors. 26. Sugar. 27. Transmission line towers. 28. Sewing Machines-hand operated, machine operated, ind4strial or otherwise. 29. Dairy Machinery Industry. 30. Food Processing Machinery and Equipment Industry. 31. All types of rubber based conveyor beltings, PVC conveyer beltings and Pan and V belts. 32. Calcium Carbide. 33. Caustic Sodi. 34. Potassium Chlorate. 35. Carbon Black. 36. Calcium Carbonate. 37. Elemental Phosphorous. 38. Sodium Chlorate. 39. Halathion Technical. 40. BBC Technical. 41. Endosulfan Technical. 42. 2-4, D. 43. Synthetic Pyrethroids. 44. Aniline. 45. Acetanilide. 46. Meta-amino Phenol. 47. or-Dinitro-benzene. 4B. Nitro-benzene. 49. Para-nitrochloro-benzene. 50. Orthonitrochloro-benzene. 51. Paranitro-toluene. 52. Orthonitrotoluene. 53. Metanitrotoluene. 54. Alcohol-based chemicals. 55. Pig iron and sponge iron. 56. Ferro Alloys. 57. Electronic components. 58. Computers, mini Computer/Micro Processor based system and allied items. 59. Digital Electronic Watches. 60. Two-way Radio Communications and Allied Equipment. 61. Chemicals & Pharmaceutical Machinery including mixers and reactors-kneading mills, -urbo mixers and the like. Filtration Equipment - filter press, rotary filters and the like. Centrifugal machines. Evaporators. Distillation equipment. Crystallizers, Driers. -247- 62. Borax. 63. Boric Acid. 64. Chemical lime. 65. PVC Power cables with Aluminum conductors. 66. Acetic Acid. 67. Distribution Transformers. 68. Dry Batteries. 69. Welding Electrodes. 70. Electric Fans. 71. Overhead Cranes. 72. Railway Wagons. 73. Industrial Gases. 74. Formaldehyde. 75. Vanadium Pentoxide Catalyst. 76. Hydrogen Peroxide. 77. Nylon Chips/Nylon Moulding Powder. 78. Industrial Explosives. -248- Attachment 4 List of Industries Allowed Automatic Growth (As of October 1984) 1/ SCHEDULE PART A 1. Metallurgical Industries: (1) Ferro alloys (2) Steel casting and forgings (3) Special steels (4) Non-ferrous metals and their alloys 2. Boilers and Steam Generating Plants 3. Prime Movers (other than electrical generators): (1) Industrial turbines (2) Internal combustion engines 4. Electrical Equipment: (1) Equipment for transmission and distribution of electricity (2) Electrical motors (3) Electrical furnaces (4) X-ray equipment (5) Electronic components and Equipment. 5. Transportation: (1) Mechanized sailing vessels up to 1,000 DWT (2) Ship ancillaries (3) Commercial vehicles 6. Industrial Machinery. 7. Machine Tools, Jigs, Fixtures, Tools and Dies of specialized types. 8. Agricultural Machinery, Tractors and Power Tillers. 9. Earthmoving Machinery. 1/ First introduced in 1975 in respect of Part B industries shown in first list. -249- 10. Industrial Instruments: including, recording and regulating devices for pressure, temperature, rate of flow, weights, levels and the like. 11. Scientific Instruments. 12. Nitrogenous and Phosphatic Fertilizers falling under: (1) Inorganic fertilizers under '18. Fertilizers' in the First Schedule to the IDR Act, 1951. 13. Chemicals (other than Fertilizers): (1) Inorganic heavy chemicals (2) Organic heavy chemicals (3) Fine Chemicals, including photographic chemicals (4) Synthetic resins and plastics (5) Synthetic rubbers (6) Man-made fibres (7) Industrial explosives (8) Insecticides, fungicides, weedicides and the like (9) Synthetic detergents (10) Miscellaneous Chemicals (for industrial use only) 14. Drugs and Pharmaceuticals: (a) Drug intermediaries from the basic stage for production of high technology bulk drugs; and (b) High technology bulk drugs from basic stage and formulation based thereon with an overall ratio of bulk drug consumption (from own manufacture) to formulation from all sources of 1:5. 15. Paper and Pulp including Paper Products 16. Automobile Tires and Tubes 17. Plate Glass 18. Ceramics: (1) Refractories (2) Furnace lining bricks - acidic, basic and neutral 19. Cement Products: (1) Portland cement (2) Asbestos cement -250- PART B In addition to industries listed in Part A above, the following industries to the extent they are not already included in Part A above: (1) Automobile ancillaries (2) Castings and closed die forgings (3) Tractors (4) Commercial vehicles (5) Conveying equipment (6) Diesel engines, pumps (7) Cranes (8) Earthmoving, mining and metallurgical equipment (9) Hydraulic equipment (10) Industrial machinery, including chemical plant and machinery (11) Machine tools (12) Textile machines (13) Power transmission and distribution equipment (other than cables and wires) (14) Power transformers (15) Switchgears PART C In addition to industries listed in Part A and Part B above, the following industries to the extent they are not already included in the aforesaid Part A and Part B: (1) Automotive castings, SG iron castings, steel castings and steel forgings (2) Non-ferrous metals and their alloys, including aluminum foils (3) Sponge Iron and Pelletisation -1-251- (4) Alternate energy systems like solar, wind, etc. & equipments therefor (5) Gas/hydro/steam turbines from 20 MW to 60 MW (6) Equipment for transmission and distribution of electricity including power relays, BT-switch gear, synchronous condensers (7) Electrical furnaces including industrial furnaces (8) Component wires for manufacture of lead-in-wires (9) Hydro/steam/gas generators from 20 MW to 60 MW (10) Mechanized sailing vessels up to 10,000 DWT including fishing trawlers (11) Commercial vehicles, public transport vehicles including automotive commercial three-wheeler jeep type vehicles, industrial locomotives (12) Personal transport vehicles: (i) Passenger cars (ii) Automotive two wheelers and three wheelers. Regarding two wheelers, only for industrial undertakings which do not fall within the purview of the Monopolies and Restrictive Trade Practices Act, 1969 (54 of 1969) or within the purview of the Foreign Exchange Regulation Act, 1973 (46 of 1973). (13) Specialized automotive components, such as pistons and piston rings, fuel injection equipment, autoelectricals, such as starter motors, generators, spark plugs, rear axle assembly, brake and clutch assembly, tire/tube valves, wheels for automobiles and bimetal bearings. (14) Industrial machinery including specialized equipment (15) High performance and high fidelity industrial valves as may be specified by the Ministry of Industry (16) Centralized lubrication systems (17) Gears, gear boxes and couplings (18) Pollution control equipment (19) Rolls for paper mills, rolls for rolling mills (20) Process equipment for utilization of recycling of wastes -252- (21) Machine tools, including controls and accessories (22) Jigs, fixtures, tools and dies of specialized types and crossland tooling (23) Engineering production aids such as cutting and forming tools, patterns and dies and mining tools (24) Earth Moving machinery and construction machinery and components thereof (25) Scientific and electromedical instruments and laboratory equipment (26) Heavy organic chemicals including petrochemicals (27) Organic fine chemicals (28) Industrial ezplo.ives (29) Technical grade insecticides, fungicides, weedicides and the like (30) Miscellaneous chemicals (for industrial use only) including: (i) Catalysts and catalyst supports (ii) Photographic chemicals (iii) Rubber chemicals (iv) Polyols (v) Isocyanates, Urethanes, etc. (vi) Speciality chemicals for enhanced oil recovery (vii) Heating fluids (viii) Coal tar distillation and products therefrom (ix) Tonnage plants for the manufacture of industrial gases (x) High altitude breathing oxygen/medical oxygen (xi) Nitrous oxide (xii) Refrigerant gases like liquid nitrogen, carbon dioxide etc. in large volumes (xiii) Argon and other rare gases (xiv) Alkali/acid resisting cement compound (xv) Leather chemicals and auxiliaries (31) Industrial laminates (32) Automobile tires and tubes, including automobile tire tube valves (33) Rubberized heavy duty industrial beltings of all types (34) Rubberized conveyor beltings (35) Rubber reinforced and lined fire fighting hose pipes -253- (36) Float glass (37) Toughened glass insulators (38) Glass fibres of all types (39) Ceramic fibres (40) Gypsum boards, wall boards and the like (41) High technology reproduction and multiplication equipment (42) Carbon and carbon products: (i) Graphite electrodes and anodes (ii) Impervious graphite blocks and sheets (43) Pretensioned high pressure RCC pipes (44) Rubber machinery (45) Printing machinery: (i) Web-Fed high speed offset rotary printing machines having output of 30,000 or more impressions per hour (ii) Photo composing/type setting machines (iii) Multi-color sheet-fed offset printing machines of size 18"z25" and above (iv) High speed rotogravure printing machines having output of 30,000 or more impressions per hour -254- Attachment 5 List of Industries Exempt from HRTP Act THE SCHEDULE 1. Pig Iron (Capacity of not more than 3 lakh tonnes) 2. Alternate Energy Systems other than Solar Photovoltic Components, Panels and Systems 3. Electronic Components and Equipments listed below: (i) Electronic Components required for the electronic industry (other than all types of Integrated Circuits viz. VISI, L3I, MSI, SSI, Semi-Conductors, Photo Voltaic Components etc.) (ii) Computer Peripherals (iii) Computer Software (iv) Magnetic Tapes for use in Computers and Video Equipment, Hard Discs, Floppy Discs and Diskettes for Computers (v) Test and Measuring Instruments (Note: Exemption in respect of the above electronic components and equipments shall be available only if the HRTP House establishes in-depth production facilities vertically integrated; it shall not be allowed to do more assembly work from the imported kits in regard to the above exempted items) 4. Industrial Machinery as listed below: (i) Pollution Control Equipment (ii) Process equipment for utilization of recycling of wastes (iii) Printing Machinery as listed below: (a) Web fed high speed letter press rotary and off-set rotary printing machines having output of 30,000 or more impressions per hour i.e. cylinder speed of 30,000 per hour. (b) Photo/composing/type setting machines and ancillaries keyboards, editing terminals and film/paper processors. (c) Four color/two color offset machines (iv) Dairy Industry Equipment Homogenizers (v) Machinery for Chemical Industry as listed below: (a) Rupture Discs (b) Special Pneumatic Calibrators Cc) Karbate pumps (d) Centrifugal Gas Compressors -255- 5. Machine Tools as listed below: (i) Crankshaft and Crankshaft running Lathes (ii) Jig boring machines (iii) Thread/worn milling and grinding machines (iv) Thread whirling and thread rolling machines (v) Cear grinding, Bevel Gear Cutter blade sharpening and grinding and Optical Profile grinding machines 5. Inorganic fertilizers under '18-Fertilizers' in the First Schedule to the I (D&R) Act, 1951, excluding fertilizer industry dealing with Single Super Phosphate. 7. Drug drug intermediates: High Technology Bulk drugs from basic stages and formulations based thereon with an overall ratio of bulk drugs consumption (from own manufacturers) to formulation from all sources of 1:5 as listed below: Rifampicin Insulin Dapsons Anti-Cancer Drugs Calofazimine Vitamin B6 Primaquin Norgestrel EMNE (Ethozy Methylene Piperazine NaLonic Ester) New Bulk Drugs developed Novaldiamine through indigenous research 8. Newsprint 9. Portland Cement -256- Atachment 6 Raising the Investment Limits for Determining Dominance and Concentration of Economic Power 1/ 1. In 1969, the MRTP Act introduced the two concepts of dominance and concentration of economic power. Concentration of economic power was sup- posed to occur if an enterprise's capital assets surpassed Re 200 million, economic dominance was a function of both control over the market share and size of undertaking. The Act defined dominance in terms of controlling one-third share of market and having assets of over Rs 10 million. 2. These size limits were presumably determined in relation to existing investment limits for industrial licensing and small scale enterprise, and to the size of the economy. Over the past 15 years these parameters have changed and yet the size limits for dominance and concentration of economic power have not been revised. The investment limit for small scale activity was raised from Rs 0.75 million in 1966 to Rs 1.0 million in 1975 and Rs 2.0 million in 1980. Similarly the cutoff point for industrial licensing was raised from Re 2.5 million in 1969 to Rs 10 million in 1970, Rs 30 million in 1977 and Rs 50 million in 1983. Since 1970/71 the increase in investment limit for the small sector was somewhat lower than the increase in the price level (threefold), while the increase for industrial licensing kept pace with the overall (nominal) growth of the economy or CNP (nearly fivefold) (see Table). On the other hand, leaving the MRTP limits unchanged in nominal terms and by nearly four-fifth in relation to the size of the economy and to the limits for industrial licensing. 11 This Attachment presents the situation prior to the presentation of the Budget on March 15, 1985. The asset limits were revised in respect of Large houses (from Rs 2 million to Rs 1 billion) small scale firms (from Rs 2 million to Rs 3.50 million) and ancillaries (from Rs 2.50 million to Rs 4.50 million). The asset limit for dominant firms controlling one- quarter of licensed capacity or output remains at Re 10 million. -257- INVESTMENT LIMITS AND POSSIBLE ALTERNATIVES Alternative A Alternative B Adjusted for Adjusted for Investment Limit Inflation Growth of Economy Categories 1970/71 1983/84 since 1970/71 since 1970/71 Ind. Licensing Re million 10 50 30 50 Small Scale Rs million 0.75 2.0 1.5 2.5 Dominant firms Ra million 10 10 30 50 Large firms Rs million 200 200 600 950 - 1000 Index GDP deflator (market prices) 100.0 300.0 a/ CDP, market prices 100.0 480.0 b/ a/ Estimated on basis of 9% inflation over 1982/83. h/ Estimated on basis of 8% real growth over 1982/83. 3. If the size limits for dominance and concentration of economic power were to be revised in parallel with the growth of the economy then the asset limit for dominance should be raised to about Rs 50 million and for large firms (concentration of economic power) to Rs 950 million to Rs 1 billion. Raising the investment limit for dominant firms to Rs 50 million is in any case desirable for equity reasons to maintain parity between existing firms and new entrants. In fact, thus raising the limits for dominance and economic concentration in parallel with the GNP would just restore the original relationship between these various limits. Keeping all limits constant in real terms (i.e., only adjusted for inflation) would point to a more modest increase to Rs 30 million for dominant undertakings, Rs 600 million for large firms and a reduction of investment limits to Rs 30 million for industrial licensing and Rs 1.5 million for small scale. The two alter- native approaches, in both cases correcting all limits by the same factor, and thereby keeping their relationships constant are also shown in the Table. On either criterion limits for dominance and size should be increased substantially. On the other hand, if nothing is done, the limits for dominance and economic power, which, in real terms, have already been reduced by a factor of 3, will continue to go down, and larger and larger parts of the enterprise sector will be subjected to restrictions which were not originally intended for them. -258- Attachment 7 Suggested Range of Size Classification for the Medium- and Large-Scale Sector (Annual Survey of Industries-Summary Factory Sector) The following size classification could be considered: (1) Re 2 million - Rs 2.50 million. (2) Rs 2.50 million to Rs 3.50 million - the limit for small scale. (3) Rs 3.50 million to Rs 4.50 million - the limit for ancillaries. (4) Rs 4.50 million to Rs 1C million - the limit for dominant undertakings. (5) Rs 10 million to Re 50 million - the limit for licensing. (6) Rs 50 million to Rs 200 million. (7) Rs 200 million to Rs 500 million. (8) Rs 500 million to Rs 750 million. (9) Rs 750 million to Rs 1 billion - the limit for large houses. (10) Rs 1 billion to Rs 1.25 billion. (11) Rs 1.25 billion to Rs 1.50 billion. (12) Above Rs 1.50 billion. For meaningful analysis however this information should be given separately for the public and private sector.