India - 1997 economic update : sustaining rapid growth

Report No. 16506-IN India 1997 Economic Update: Sustaining Rapid Growth May 30, 1997 Country Operations, Industry & Finance Division Country Department II South Asia Region U Document Of the wormd Bank  CURRENCY Rs/ US$ Currency Official Unified Market a Prior to June 1966 4.76 June 6, 1966 to mid-December 1971 7.50 Mid-December 1971 to end-June 1972 7.28 1971-72 7.44 1972-73 7.71 1973-74 7.79 1974-75 7.98 1975-76 8.65 1976-77 8.94 1977-78 8.56 1978-79 8.21 1979-80 8.08 1980-81 7.89 1981-82 8.93 1982-83 9.63 1983-84 10.31 1984-85 11.89 1985-86 12.24 1986-87 12.79 1987-88 12.97 1988-89 14.48 1989-90 16.66 1990-91 17.95 1991-92 24.52 1992-93 26.41 30.65 1993-94 31.36 1994-95 31.40 1995-96 33.46 1996-97 35.50 Note: The Indian fiscal year runs from April 1 through March 31. Source: IMF, International Finance Statistics (IFS), line "rf"; Reserve Bank of India. A dual exchange rate system was created in March 1992, with a free market for about 60 percent of foreign exchange transactions. The exchange rate was reunified at the beginning of March 1993 at the free market rate. Vice President Mieko Nishimizu Directors Robert S. Drysdale, Edwin Lim Division Chief Luis E. Derbez Staff Member Zoubida Allaoua, Senior Economist  ABBREVIATIONS AND ACRONYMS BE Budget Estimates MPBF Maximum Permissible Bank Finance BOLT Build-Operate-Lease-Transfer MTM Mark to Market BOP Balance of Payments MTO Multimodal Transport services BOO Build-Won-Operate MUV Manufactures Unit Value BOT Build-Operate-Transfer MW Megawatt BSE Bombay Stock Exchange NBFCs Non Bank Financial Companies CEA Central Electricity Authority NCAER National Council of Applied Economic CEM Country Economic Memorandum Research CERC Central Electricity Regulatory Commission NFA Net Financial Assets CFS Container Freight Station NHAI National Highways Authority of India CGE Computable General Equilibrium NPV Net Present Value CMNAP Common Minimum National Action Plan NRER(A) Non-Resident External Rupee Account CMP Common Minimum Program NSE National Stock Exchange CONCOR Container Corporation of India NTB Non-Tariff Barriers CRR Cash Reserve Requirement NTPC National Thermal Power Corporation CSO Central Statistical Organization O&M Overhaul and Maintenance DOT Department of Telecommunications OCC Oil Coordination Committee DRS Debt Reporting System OECD Organization for Economic Cooperation EAS Employment Assurance Scheme and Development ECB Euro-Convertible Bond OTCEI Over-the-Counter Exchange EU European Union (formerly the EC) ONGC Oil and Natural Gas Corporation FCI Food Corporation of India PD Primary Dealers FCNRA Foreign Currency (Non-Resident) Accounts PDS Public Distribution System FDI Foreign Direct Investment PE Public Enterprise/ Fll Foreign Institutional Investor PLF Plant Load Factor FIPB Foreign Investment Promotion Board PLR Prime Lending Rate GATT General Agreement on Tariffs and Trade POL Petroleum, Oil and Lubricants GDP Gross Domestic Product PPP Purchasing Power Parity GDR Global Depository Receipts PRI Panchayati Raj Institutions GNFS Goods and Non-factor Services PWD Public Works Department GNP Gross National Product R&D Research and Development GOI Government of India RBI Reserve Bank of India HSEB Haryana State Electricity Board RE Revised Estimates HUDCO Housing and Urban Development REB Regional Electricity Board Corporation RER Real Exchange Rate HYV High Yielding Varieties REER Real Effective Exchange Rate ICD Inland Container Depot RLDC Regional Load Dispatch Center ICDS Integrated Child Development Scheme RRB Rural Regional Bank ICICI Industrial Credit and Investment SAIL Steel Authority of India Ltd. Corporation of India SBI State Bank of India IDBI Industrial Development Bank of India SC Scheduled Castes IDF Indian Development Forum SCICI Shipping Credit and Investment IDFC Infrastructure Development Finance Corporation of India Company SDP State Domestic Product IFCl Industrial Financial Corporation of India SDR Special Drawing Rights IGIDR Indira Gandhi Institute for Development SEB State Electricity Board Research SEBI Security and Exchange Board of India lIP Index of Industrial Production SERC State Electricity Regulatory Commission IMF International Monetary Fund SICA Sick Industrial Companies Act IOC Indian Oil Corporation SIL Special Import License IPP Independent Power Producers SITC Standard Industrial Trade Classification IRDP Integrated Rural Development Program SLR Statutory Liquidity Requirements ISO International Standards Organization SSA Sub-Saharan Africa JRY Jawahar Rozgar Yojana SSI Small Scale Industry Kwh Kilowatt-hour ST Scheduled Tribes LAC Latin America and the Caribbean STCI Securities Trading Corporation of India MAT Minimum Alternative Tax TFC Tenth Finance Commission MFA Multifiber Agreement TOT Terms of Trade MFIL Mahindra Ford India Limited TRAI Telecom Regulatory Authority of India MMMF Money Market Mutual Fund TRIPS Traded Intellectual Property Rights MODVAT Modified Value Added Tax UP Uttar Pradesh MOF Ministry of Finance UT Union Territory MOP Ministry of Power VAT Value Added Tax MOST Ministry of Surface Transport WPI Wholesale Price Index MOU Memorandum of Understanding WTO World Trade Organization   CONTENTS Currency Abbreviations and Acronyms Acknowledgments Economic Development Date Executive Summary Chapter 1 Recent Economic Developments ........................................................................I A. Recent Economic Developments ......................................................................1I A strong supply response ......................................................................1I Strong saving and investment performance ....................................................................2 Fiscal developments remain a serious concern ...............................................................2 Monetary policy eased but inflation remains moderate ...................... ............................3 Exports and imports growth slowed down; the external accounts remain strong ...........5 B. Highlights of Structural Reformns .......................................................................6 Increase in competition .......................................................................6 Structural reforms have continued in 1996-97 ................................................................9 Agriculture is becoming a focus of reform ................................................................... 14 C. Economic Management Issues ...................................................................... 14 Possible slow down in investment and growth ............................................................. 16 The 1997-98 budget: a creative but fiscally risky supply-side initiative ...................... 16 Fiscal adjustment in the 1997-98 budget ...................................................................... 18 Fiscal vulnerabilities ...................................................................... 18 External account vulnerabilities ....................................................................... 21 Chapter 2 Changing States' Development Policies ....................................................................... 21 A. States Issues: A Summing Up ...................... ................................................. 21 India's pre- 1991 development strategy and inter-government transfers have shaped the states' development policies .................................................................. 21 Some aspects of the system of transfers have discouraged states' fiscal discipline ...... 23 The states face three crises--fiscal, infrastructure, human resources development ....... 24 B. State Reforms: Priorities and Progress ...................................................................... 28 Reforming infrastructure policies ....................................................................... 28 Restructuring states' public expenditures ..................................................................... 31 Strengthening resource mobilization ...................................................................... 32 Improving inter-governmental transfers ...................................................................... 32 Chapter 3 Sustaining Rapid Growth ...................................................................... 33 A. Policy Priorities ....................................................................... 33 B. External Prospects and Financing ...................................................................... 36 Annex ....................................................................... 39 Statistical Appendix ...................................................................... 55  List of Tables Table 1.1 Evolution of the Public Deficit, 1990-97 ....................................................2 Table 1.2 Merchandise Export and Import Slowdown, 1995-1996 ................................................5 Table 1.3 Industrial Disputes: 1981-85 to 1995-96 .....................................................9 Table 1.4 Summary of Domestic and External Trade Reforms, 1995-96 to IS197-98 .................. 15 Table 2.1 India - State Profiles, 1995-96 .................................................... 22 Table 2.2 Central Plan Loans as a Percentage of Plan Capital Expenditure of States .................. 25 List of Boxes Box 1.1 The High Cost of Government Subsidies .....................................................3 Box 1.2 The Automobile Industry's Response to Liberalization ................................................7 Box 1.3 State Bank of India (SBI) Responds to Competition .....................................................8 Box 1.4 Improving Corporate Governance in India .....................................................8 Box 1.5 Non-Bank Financial Companies .................................................... 13 Box 1.6 1997-98 Budget Main Tax Measures .................................................... 17 Box 1.7 The Targeted Public Distribution System .................................................... 19 Box 2.1 Reforms in Rajasthan .................................................... 27 Box 2.2 Establishing Fiscal Sustainability in Andhra Pradesh ................................................... 28 Box 2.3 State Power Reforms: A Beginning .................................................... 29 Box 2.4 The December 1996 Common Minimum National Action Plan for ]?ower .................. 30 Box 2.5: Haryana Sees the Benefits of Reform .................................................... 31 List of Figures Figure 1.1 Economic Growth ....................................................I Figure 1.2 Trends in manufacturing Growth .....................................................2 Figure 1.3 Trends in Savings .....................................................2 Figure 1.4 Gross Domestic Investment .....................................................3 Figure 1.5 Money Supply .....................................................4 Figure 1.6 Inflation Rates ......... . . . . ... . . 4 Figure 1.7 Year to Date Nominal export Growth, 1991-1996 ..........................................5 Figure 1.8 Export Growth, 1990-1996 ..........................................5 Figure 1.9 Exchange Rate Movements ..........................................5 Figure 1.10 Foreign Investment ..........................................6 Figure 1.11 Funds Raised by the Financial Institutions During 1995-96 ......................................... 12 Figure 1.12 Non-Perforrming Advances ......................................... 14 Figure 1.13 Trends in the Stock Markets ..................................... 16 Figure 2.1 Net Transfers to States as a Percent of GDP ..................................... 24 Figure 2.2 Key Components of State Governments' Expenditure ..................................... 24 Figure 2.3 States' Debt vrs Per-capaita Income ..................................... 32 Figure 3.1 Debt and Non-Debt Flows ..................................... 38  ACKNOWLEDGMENTS This report was prepared by a team led by Tzanninis and Martin Muhleisen (IMF). Zoubida Allaoua. It draws on contributions Primary statistical and computational from Mona Haddad, William Mccarten, V.J. assistance was received from Bhaskar Naidu Ravishankar (state issues, fiscal), Miria and Rajni Khanna. The report benefitted from Pigato and Uri Dadush (external sectors), Luis Ernesto Derbez (Division Chief) Dina Umali-Deininger (agriculture), Joelle continuous support. Chassard, Kari Nyman, Djamal Mostefai (power), Harald Hansen (transport). Roberto The report benefitted from and reflects Zagha (Lead Economist) contributed to the discussions held with the Indian authorities in report and provided guidance. Rui Coutinho May 1997. We gratefully acknowledge the who participated in the discussions with the cooperation of government officials, the RBI, government also provided invaluable and members of the business community for assistance. The report benefited from their valuable time and assistance. comments from John Williamson (Chief Economist), Luis Serven (reviewer), Colin Arrangements for mission to India were made Bruce, Sanjay Kathuria, Benoit Blarel, Keith by Padma Gopalan and Sheni Rana. The Hinchliff, James Hanson, and Dimitri report was desktoped by Lin Chin.   ECONOMIC DEVELOPMENT DATA GNP Per Capita (US$, 1995-96): 350' Gross Domestic Product (1995-96) Annual Growth Rate (% p.a, constant prices) % of 70-71- 75-76- 80-81- 85-86- 91-92 92-93- US$ Bln GDP 75-76 80-81 85-86 90-91 95-96 GDP at Factor Cost 294.6 89.7 3.4 4.2 5.4 5.9 0.8 6.4 GDP at Market Prices 328.3 100.0 3.3 4.2 5.6 6.2 0.4 6.3 GrossDomesticlnvestment 86.1 26.2 5.3 3.7 5.7 9.5 -11.0 12.8 Gross National Saving 79.8 24.3 4.4 2.6 3.5 8.7 -0.3 10.7 Current Account Balance -6.4 -1.9 -- - -- -- -- -- Output, Employment and Productivity (1990-91) Value Added Labor Force b V. A. per Worker US$ Bln. % of Tot Mill. % of Tot. US$ % of Avg. Agriculture 82.5 31.0 186.2 66.8 443 46.4 Industry 78.0 29.3 35.5 12.7 2198 230.2 Services 105.7 39.7 57.2 20.5 1848 193.7 Total/ Average 266.2 100.0 278.9 100.0 954 100.0 Government Finance General Government Central Government Rs. Bin. % of GDP Rs. Bln. % of GDP 95-96 95-96 90-91-95-96 95-96 95-96 90-91-95-96 RevenueReceipts 2174.1 19.8 19.6 1101.3 10.0 10.1 Revenue Expenditures 2539.5 23.1 23.3 1398.6 12.7 13.2 Revenue Surplus/ Deficit (-) -365.3 -3.3 -3.7 -297.3 -2.7 -3.1 Capital Expenditures d 416.2 3.8 4.2 305.1 2.8 3.4 External Assistance (net) e 3.2 0.0 0.6 3.2 0.0 0.6 Money, Credit, and Prices 89-90 90-91 91-92 92-93 93-94 94-95 95-96 (Rs. billion outstanding, end of period) Money and Quasi Money 2309.5 2658.3 3170.5 3668.3 4344.1 5308.0 6018.4 Bank Credit to Govermnent (net) 1171.5 1401.9 1582.6 1762.4 2039.2 2224.2 2574.1 Bank Credit to Commercial Sector 1517.0 1717.7 1879.9 2201.4 2377.7 2896.6 3409.0 (percentage or index numbers) Money and Quasi Money as % of GDP 50.6 49.6 51.4 52.0 53.7 55.7 54.8 Wholesale Price Index (1981-82 = 100) 165.7 182.7 207.8 228.7 247.8 274.7 294.8 Annual Percentage Changes in: Wholesale Price Index 7.4 10.3 13.7 10.1 8.4 10.9 7.3 Bank Credit to Government (net) 20.3 19.7 12.9 11.4 15.7 9.1 15.7 Bank Credit to Commercial Sector 14.4 13.2 9.4 17.1 8.0 21.8 17.7 a The per capita GNP estimate is at market prices, using World Bank Atlas methodology. Other conversions to dollars in this table are at the prevailing average exchange rate for the period covered. b. Total Labor Force from 1991 Census. Excludes data for Assam and Jammu & Kashmir. c. Transfers between Centre and States have been netted out. d. All loans and advances to third parties have been netted out. e. As recorded in the government budget.  Balance of Payments (US$ Millions) Merchandise Exports (Average 1990-91-1995-96) 1993-94 1994-95 1995-96 US$ Mil % of Tot. Exports of Goods & NFS 27,947 32,760 39,636 Tea 404 2.1 Merchandise, fob 22,683 26,857 32,467 Iron Ore 487 2.5 Imports of Goods & NFS 29,798 38,150 48,540 Chemicals 1,891 9.6 Merchandise, cif 25,069 31,840 41,405 Leather & Leather products 1,439 7.3 of which Crude Petroleum 3,407 3,285 3,442 Textiles 2,708 13.8 of which Petroleum Products 2,244 2,396 3,759 Garments 2,731 13.9 Trade Balance -2,386 -4,983 -8,938 Gems and Jewelry 3,753 19.1 Non Factor Service (net) 535 -407 34 Engineering Goods 2,832 14.4 Others 3,423 17.4 Resource Balance -1,851 -5,390 -8,904 Total 19,667 100.0 Net factor Incomea -3,775 -3,621 -4,945 External Debt, March 31, 1996 Net Transfersb 3,825 6,200 7,480 US$ Mill. Balance on Current Account -1,801 -2,811 -6,369 Public & Publicly Guaranteed 79,725 Private Non-Guaranteed 6,618 Foreign Investment 4,235 4,895 4,347 Total (Including IMF and Short Term) 93,766 Official Grants and Aid 368 472 416 Net Medium & Long Term Capital 3,122 1,153 -1,036 Debt Service Ratio for 1995-96 Gross Disbursements 8,247 6,800 6,689 Principal Repayments 4,027 4,828 6,780 % curr receipts Public & Publicly Guaranteed 21.8 Other Capital Flowsc 1,516 2,330 -308 Private Non-Guaranteed 14.7 Non-Resident Deposits 1,097 818 945 Total (Including IMF and Short Term) 28.1 Net Transactions with IMF 189 -1,174 -1,719 IBRD/ IDA Lending, March 31, 1996 (US$ Mill) Overall Balance 8,538 6,858 -2,005 IBRD IDA Change in Net Reserves 8,727 5,684 -3,724 Outstanding and Disbursed 9,767 17,499 Gross Reserves (end of yeard 15,476 21,160 17,436 Undisbursed 4,116 4,583 Outstanding incl. Undisb. 13,883 22,082 Rate of Exchange End-March 1997e US$ 1.00 = Rs. 34.80 - Not available. a. Figures given cover all investment income (net). Major payments are interest on foreign loans and charges paid to IMF, and major receipts is interest earned on foreign assets. b. Figures given include workers' remittances but exclude official grant assistance which is included within official loans and grants, and non-resident deposits which are shown separately. c. Includes short-term net capital inflow, changes in reserve valuation and other items. d. Excluding gold. e. The exchange rate was reunified at the market rate in March 1993. f Total exports (commerce); net of crude petroleum exports.  India Social Indicators Latest single year Some region/income group 1970-75 198045 1990-95 South Asia Low-income POPULATION Total population, mid-year (millions) 613.5 765.2 929.4 1,243.00 3,179.90 Growth rate (% annual average) 2.3 2.1 1.7 1.9 1.6 Urban population (% of population) 21.3 24.3 26.8 26.4 28.6 Total fertility rate (births per women) 5.6 4.8 3.2 3.5 3.2 POVERTY ('% of population) National headcount index* .. .. 35.0 Urban headcount index .. .. 30.51 Rural headcount .. .. 36.7 INCOME GNP per capita (US$) 180 280 350 350 430 Consumer price index (1990=100) 36 70 165 Food price index (1990=100) .. 66 174 INCOME/CONSUMPTION DISTRIBUTION (% of income or consumption) Lowest quintile 5.9 - 8.1 8.5 Highest quintile 49.4 41.4 42.6 SOCIAL INDICATORS Public expenditure (l% of GDP) Health .. .. 0.7 Education 2.1 2.5 2.9 Social security and welfare Net primary school enrollment rate (3/ of age group) Total Male Female Access to safe water ('/o of population) Total 31 54 63 63.2 53 Urban Rural Immunization rate (% under 12 months) Measles .. .. 84 80 77 DPT .. 41 92 84 80 Child malnutrition (% under 5 years) .. .. 63 61 42 Life expectancy at birth (years) Total 50 55 62 61 63 Male 51 56 62 61 62 Female 49 55 63 62 64 Mortality Infant (per thousand live births) 132 108 68 75 69 Under 5 (per thousand live births) .. .. 95 106 104 Adult (15-59) Male (per 1,000 population) , 229 239 244 Female (per 1,000 population) .. .. 219 230 211 Maternal (per 100,000 live births) .. 460 437 * Data for 1993-94 Source: World Development Indicators CD-ROM, World Bank, February 1997 and India: Poverty Assessment Report.   EXECUTIVE SUMMARY 1. A number of reports issued in 1996-97 (the reduction of the central government fiscal deficit, Ministry of Finance's Economic Survey; the Reserve consolidated fiscal imbalances remain serious, Bank of India's (RBI) Annual Report; the RBI Report however, and excessively slow progress is being made on Currency and Finance; the RBI Report on Trend to correct them. A May 1997 government paper shows and Progress of Banking in India; the India that implicit and explicit subsidies for "non-merit" Development Report (IGIDR); the government goods absorb an alarming 11 percent of GDP and are a appointed Expert Group Report on Infrastructure; the major factor behind India's chronically high fiscal 1997-98 Budget speech; the RBI April Credit Policy; deficits. Inflation has increased moderately (from and the May 1997 Ministry of Finance's discussion below 5 percent in May 1996 to 6 percent in May paper on government subsidies) document 1997, point-to-point), partly the result of a more comprehensively India's past and recent performance, expansionary monetary stance (broad money growth articulate the governments' development objectives, accelerated from 13.7 percent to 15.6 percent). and provide an accurate picture of the policy challenges the country faces. Because of the 3. Underlying the economy's strong economic comprehensiveness and depth of this documentation to performance are important structural transformations. which interested readers are referred to, this report The declining role of the public sector since the start of comments only on salient recent economic and policy the reform program in 1991, both as producer of goods developments. and services and economic regulator, is one of India's most fundamental structural change since The Economy is Stronger and More Independence. The liberalization of the economy has Competitive opened to the private sector areas previously the exclusive domain of the public sector--such as heavy 2. The reforms of the past six years brought manufacturing, banking, civil aviation, about an unprecedented strong economic telecommunications, power generation and performance. For the third year in a row, GDP is distribution, ports, and roads. Equally important, the estimated to have grown by about 7 percent in the liberalization of the economy has reduced distortions fiscal year 1996-97 ending on March 31, placing India and increased external and internal competition. among the world's best performing economies. Unlike similar episodes in the past, this expansion has been 4. In agriculture, the sector's terms of trade have driven by private investment (which reached the improved. As a result, agricultural commodities have historically high level of 18 percent of GDP out of a been one of India's fastest growing exports, and total investment of 26 percent in the last two years), commercial crops are expanding rapidly. In Industy, and has not put pressure on the balance of payments. In firms are restructuring and entering into joint ventures spite of the persistent poor performance of public and alliances with foreign firms. Productivity has savings, national savings have risen (from 23 percent increased and consumers have a wider range of better of GDP in 1991-92 to 26 percent of GDP in 1996-97). quality goods from which to choose. Important The country's external position is strong. The current legislative changes, deregulation, and foreign investors account deficit was 1.1 percent of GDP in 1996-97; the are improving corporate governance of industrial and country's US$94 billion external debt declined to 27 financial firms. The regulatory and institutional percent of GDP in 1996-97 from 34 percent in 1991- framework of the ftnancial sector has been 92, and the debt service to 24 percent of current strengthened considerably. In the banking system, account receipts from 29 percent. In spite of the although still vulnerable, the financial health of the  ii Executive Summary public banks has improved and 19 out of the 27 public with some degree of success, particularly in bridges. sector banks reached the capital adequacy ratio of 8 Also, legislative changes have been announced to percent in 1995-96. The entry of new private banks and facilitate land acquisition--an irnportant impediment to the mainstreaming of Non-Bank Finance Companies private investment in roads. In power, where the need (NBFCs) in a financial sector still dominated by public is the greatest, private sector interest to invest the banks (which control 85 percent of the system's assets) strongest, and action by state governments essential to have increased competition and forced the latter to transform this interest into concrete investments, a reduce costs, and improve quality of service. Similar conference of state Chief Ministers reached agreement developments have taken place in civil aviation. In on a Common Minimum National Action Plan for infrastructure, while much too slowly to address Power (CMNAP) reforms, issued by the Ministry of India's infrastructure crisis, private investrnent is Power in December 1996. Much of the CMNAP has taking place in ports, power, and toll bridges. A new been inspired by the pioneering reforms Orissa started financial institution (IDFC) has been established to a few years ago. The CMNAP envisages changes in facilitate the development of a long-term rupee bond legislation to enable the states to have their own market for infrastructure financing. Last but not least, independent power regulatory agencies, with authority increased competition in product markets has led to an to grant licenses including for distribution, and fix improvement in industrial relations with a consequent tariffs. This would remove the main impediments to decline in labor disputes. large scale private investment in a sector that needs it urgently. Some states are giving the CMNAP's 5. Reforms have continued during 1996-97 in recommendations serious consiideration and taken steps spite of political uncertainty. The positive effects of towards their implementation. In coal, major reforms the reforms have demonstrated the extent to which have freed imports from licensing restrictions, reduced India stands to gain from deregulation and better fiscal tariffs to 5-10 percent, pursued the liberalization of management, and have helped create some consensus private investment in the sector, lifted price controls on on the need to continue liberalizing the economy and high grade coal and will lift the remaining restrictions correcting fiscal imbalances. This may explain why, over the next 2-3 years. Also, a decision was taken to notwithstanding three changes of government of very divest shares in Coal India's subsidiaries. diverse political backgrounds, reforms have continued in 1996-97 and expanded into some new areas, albeit at 7. This progress notwithstanding, it is evident that a rate that can be seen as excessively gradual. the induction of private capital in areas which for decades have been under publjic sector monopoly has 6. The investment regime has been liberalized been slower than anticipated, and so have its results. further, with particular emphasis on foreign Unless investment in infrastructure expands investment--approval procedures have been simplified significantly, India's emerging infrastructure crisis may and restrictions on end-use relaxed. Announced a few prevent the country from sustaining the high levels of years ago, the independent Telecom Regulatory growth that the last few years have shown to be within Authority of India has started its operations. In the reach. In particular, remarkably little progress has been case of major ports (regulated by the central made in addressing the fundamental policy and government), an independent Tariff Authority was institutional changes (most of which under the established, guidelines have been issued for private exclusive purview of state authorities) needed to investment through BOT-type contracts. Several expand urban infrastructure and alleviate the private investments in minor ports (under the states' tremendous problems of India's fast growing cities. jurisdiction) have already taken place. In roads, while Water supply systems--rural and urban--continue to be there is awareness in India that this is an area where the poorly managed by state-government institutions at a public sector will retain a major role, attempts have high cost to the economy (the subsidy for irrigation been made nonetheless to facilitate private sector entry  Executive Summary iii alone is close to 2 percent of GDP) and insufficient has promoted the National Securities Depository efforts are being made to attract private investment. Limited (NSDL) to facilitate scripless trading and the National Clearing Corporation Limited (NCCL) to 8. The liberalization of the *rade regime has guarantee all trade done on the NSE. Screen-based continued. Tariff reductions announced in the 1997-98 trading has now been generalized to other exchanges. Budget presented to Parliament in February 1997 All transactions in debt securities, previously handled brought the maximum rate down to 40 percent and the by brokers in an unregulated telephone market, are average import-weighted rate to 20 percent. The now done solely through the NSE which has emerged Finance Minister announced its intention to reduce it as the premier exchange for scripless trading in debt as further to East Asian levels. The new Exim Policy well as stock instruments. Finally, SEBI, the securities eliminated licensing requirements for about one-sixth and exchange board of India, is strengthening its of consumer goods (essentially, the only imports still oversight capacity and the transparency of capital restricted) and India has indicated its readiness to markets. It has introduced inter alia new and more eliminate gradually the remaining licensing effective guidelines for public issues and takeovers. restrictions. 11. A key objective of the tax reform pursued by 9. Several measures were taken also to the Center since 1991 has been to simplify and broaden strengthen the banking system, increase banks' the base of the tax system by lowering rates, operational autonomy, and improve the functioning streamlining the rate structure, and improving tax of financial markets. Of particular importance, banks administration. Some of the most severe distortions of are now required to mark to market 60 percent of their the tax system have been corrected. The 1997-98 portfolios. Virtually all interest rates are now market Budget maintains the overall direction of tax reforms. determined with the exception of interest rates on In particular, it simplified India's tax system further, lending for amounts below Rs. 200,000, and on reduced import tariffs, and brought corporate and deposits of below one year. Cash reserve requirements personal rates in line with those of East Asia. In the were reduced from 14 percent of deposits in April process, the budget also seeks to improve the rules 1996 to 10 percent in January 1997; reserve governing tax sharing between the central government requirements on inter-bank liabilities have been and the states and strengthen compliance. abolished; regulations governing loan syndication and amounts of credit for working capital purposes have 12. There was also some progress in deregulating been eliminated; and prudential regulations were agriculture. The strong response of agriculture to tightened further. The elimination of CRR on inter- reforms created favorable conditions for the bank liabilities coupled with the RBI's rationalization government to re-introduce--after a 31-year hiatus-- of its refinance rates into a single rate is expected to futures trading in cotton lint, jute and jute goods and help establish a reference interest rate which would partially lift restrictions on commodity trading such as help develop a yield curve and improve RBI's ability those on storage, credit and movement controls, to manage monetary and exchange rate policies. particularly for cotton and oUlseeds. Export quotas on cotton and cotton yam were raised and the number of 10. Regarding capital markets, the Depositories yam quota exemptions expanded. Sugar exports Act was passed to provide the legal framework for the (subject to quotas) were decanalized in January 1997. dematerialization of securities and their secure transfer To boost rice exports, the government removed the through electronic book entry. The establishment of the minimum export price but declining government stocks modem electronic securities exchange system, the led to the reimposition of the levy on rice mills National Stock Exchange (NSE), transformed the exporting non-basmati rice. Recent liberalization functioning of the stock markets in India by increasing measures notwithstanding, agriculture continues to be their transparency through scripless trading. The NSE  iv Executive Summary highly regulated by both central and state governments 15. The authorities responded to this situation at a high cost to the economy and the poor. through a number of measures taken at different points in time. First, there was a relaxation of monetary 13. There was less progress in reforming public policies which led to a decline in short-term real enterprise (PEs), however. While public enterprises interest rates. Second, a number of measures were are now more exposed to competition, their autonomy introduced to encourage private investment-- remains limited and this has reduced the ability of their particularly FDI. These were the removal of entry managers to introduce essential restructuring. Thus, barriers (reservation policy) to a number of industries-- with a few exceptions, the financial performance of mostly selected agro-industries--and relaxation of scale PEs has failed to improve. A Disinvestment limitations. Third, important regulatory changes were Commission which was established in 1996 to examnine introduced to facilitate private investment in options for reducing central government equity in infrastructure. Finally, a pro-reform budget aimed at central public enterprises has since submitted an boosting confidence was presented to Parliament on approach paper and two reports articulating a strategy-- February 28, 1997. which was amply debated by the public at large and experts in the privatization field--for reforming PEs on 16. The 1997-98 budget: a creative but fiscally the basis of which the Commission recommended the risky supply-side initiative. The main objective of the full or partial privatization of nine public enterprises. 1997-98 Budget is to reactivate private investment. While these are positive steps, there are no signs yet Towards this objective, several measures were taken to that its recommendations will be adopted by the revive the stock market. Corporate taxation was govermnent and that a rapid process of disinvestment sharply reduced (from 43 percent to 35 percent) and is will take place. now in line with that in East Asia. Dividend taxation at the individual income tax level was repealed and Economic Management Issues replaced by a 10 percent final withholding on corporate distributions. Other measures (such as allowing share 14. Possible slowdown in investment and growth. buy-backs, announcing the reform of the Company's During 1996-97, a number of developments raised Act, and increasing the cap on ownership by foreign apprehension on the future course of the economy and institutional investors in Indian companies from 24 on its capacity to sustain the rates of growth of the last percent of paid-up capital to 30 percent) were intended three years. In particular, declines in the rates of to improve the business climate, increase private growth of imports of capital goods (which declined by investment, and sustain growth. Combined with 7 percent), of corporate profits (5 percent), of lending improvements in tax administration, the reactivation commitments by specialized long-term financial of private investment is critical to achieve the 1997-98 institutions (30 percent), and of primary equity issues fiscal deficit target of 4.5 percent of GDP and (22 percent) gave rise to the perception that investment represents the main downside risks of an otherwise and growth might have declined. The reasons were credible budget forecast. The 'budget also reduced the believed to be a tepid stock market which led maximum marginal personal income tax rate to 30 corporations to delay security issues; high real interest percent from 40 percent and the lowest rate to 10 rates; and commercial banks' heightened aversion to percent from 15 percent; further simplified the excise risk (largely a result of tighter enforcement of tax structure; and introduced measures to strengthen prudential regulations and the Indian Bank debacle), all compliance. Also, tariff reductions for capital goods of which made it difficult to reach financial closure on were more pronounced than for the rest. investment projects, leading many firms to postpone investment decisions. Political uncertainty was an 17. Fiscal adjustment in the 1996-97 and 1997-98 obvious additional factor. budgets. Deferred pay adjustments associated with the Fifth Pay Commission's recommendations (for which  Executive Summary v 0.3 percent of GDP had been budgeted) into 1997-98 amounts of central government grants to each state and other minor expenditure adjustment offset the and, until the 1996 Tenth Finance Commission which impact of a shortfall in privatization (0.4 percent of discontinued this practice, on unconditional debt GDP) proceeds, allowing the government to meet its forgiveness for highly indebted states. Driven mostly fiscal deficit target of 5 percent of GDP in 1996-97 by the objective of mobilizing finance for the (from 5.5 percent of GDP in 1995-96). The 1997-98 investment plans of the states, the Planning budget projects a 0.5 percent fiscal correction to 4.5 Commission makes recommendations on central percent of GDP in 1997-98 to be achieved mainly by government loans and grants to the states, and on the maintaining tax revenue at its current share of GDP, amounts of states' borrowings from captive sources: and modestly accelerating privatization. However, this "'market borrowings" from commercial banks, fiscal deficit target may be difficult to achieve without insurance companies and pension funds, all of which additional measures. In particular, the budget relies must invest a share of their resources in "designated upon improved compliance to offset the impact of the securities", such as state bonds. sharp cuts in taxation and maintain tax revenue at its current share of GDP. 20. Starting in the early 1970s, both the Finance and the Planning Commissions recommended Changing States' Development Policies gradually but persistently increasing transfers to the states. These developments built expectations that the 18. India's pre-1991 development strategy and states needed not be overly concerned with mobilizing inter-governmental transfers have shaped the states' resources since ever-expanding and politically more development and fiscal policies. The Indian expedient financing would be forthcoming. As a result, Constitution gives the states considerable autonomy to throughout the 1970s and 1980s, the states rapidly define their development policies. The states are expanded investments in physical infrastructure responsible for the provision and regulation of key (power, irrigation, ports, roads), and provision of social infrastructure and social services, including primary services, without establishing mechanisms for cost education and basic health. They defined their recovery and for maintaining these assets and programs development policies at a time when national policies in the long run. Prices charged for power, water, excluded private investment from key sectors of the irrigation and other services declined to levels economy. Where permitted, central licensing equivalent to a small fraction--in some cases zero--of authorities, not the enabling environment, determined production costs. the volume and composition of private investment. Consequently, across India, states' development 21. The states face three crises-fiscal, policies focused on expanding public investment, often infrastructure, and human resource development By in areas which are not the public sector's comparative the second half of the 1980s, it became evident that the advantage. For this expansion, they relied on transfers states were experiencing considerable fiscal recommended by the Finance and Planning difficulties. Implicit and explicit subsidies for goods Commissions, two institutions which command and services which are not of a public nature rose to considerable respect in India, and whose reach about 7 percent of GDP. They also expanded recommendations are generally accepted by the central public employment to the point that in most states government. wages and pensions absorb between 4-5 percent of the state GDP, and 9-10 percent is not infrequent. They 19. Driven mainly by the objective of equalizing contracted debt without establishing the financial base the availability of infrastructure and social services for its servicing. As a result, fiscal stress became across India, Finance Commissions make evident. In particular, there was a deterioration in the recommendations: on how to share with each state quality of spending. While the states' fiscal deficit taxes collected by the central government, on the remained relatively stable at around 3 percent of GDP,  vi Executive Summary capital, education, health and operations and on employment, and reduction of consumption maintenance expenditure started to decline from the subsidies) to eliminate wasiteful spending and make mid-1980s, and interest expenditure to increase. room for priority programs in public infrastructure, Resources for operations and maintenance became health and education; and (iv) tax reforms to provide insufficient and infrastructure begun to exhibit signs of stable sources of revenue at a low efficiency cost. decay. These trends were exacerbated by the reforms started in 1991 when growth of central government 24. In many states, policy, pricing and institutional transfers declined and eventually became negative, and reforms of key sectors would bring about the needed interest payments increased. Most states found fiscal restructuring. For example, power and irrigation themselves unable to play their central role in India's sector reforms--particularly increases in power and development: to provide key infrastructure, health, and water tariffs--would generate large fiscal gains in education. virtually all of India's 25 states. In some states, such reforms, alone, would be sufficient to restore fiscal State Reforms: Priorities and Progress sustainability. In others, putting the states' public finances on a sustainable path would require more 22. The reforms underway since 1991 have comprehensive reforms of public expenditures, such as radically changed the framework within which states' public enterprise reform, freeze on public employment, development policies are implemented. States can reduction in consumption subsidies and a attract private capital in such sectors as power, rationalization and retargeting of the states' welfare irrigation, ports, roads, and all areas of manufacturing-- programs. Finally, in highly indebted states, sectoral and it is its ability to attract private capital which now reforms and public expenditure restructuring may need determines a state's growth performance. Development to be complemented by debt refinancing. spending therefore needs to be more narrowly focused on the state's areas of comparative advantage, where it 25. Several states have already started to implement complements rather than substitutes for the private sector reforms, particularly in power-where about five sector. This is a radical departure from the pre-1991 states have taken the first steps towards increasing period, when the volume of public development tariffs, establishing an independent regulatory agency, spending was a key determinant of a state's growth and privatizing generation and distribution in a process performance. of reform that will take several years to be brought to its logical conclusion--ports, roads, and, to a lesser 23. Attracting private capital requires states to extent, water and irrigation, although a few states have provide an enabling and investor-friendly environment. already begun moderately adjusting water tariffs, and That is, good quality and abundant infrastructure, an devolving maintenance to farmers' associations. Albeit educated labor force, a business-friendly public extremely modest, some progress has also been made administration, and moderate levels of taxation. in restructuring public expenditure with a view to Significant reforms are needed to bring this about in reducing unproductive expenditure. In particular, there India's states. In particular, it requires: (i) policy, is growing recognition of the need to control pricing, institutional, and regulatory reforms to recruitment to reduce the wage bill, eliminate poorly translate private sector interest to invest in targeted welfare programs, and privatize public infrastructure into commercially viable ventures--and enterprises. On the revenuefront, reforms are needed improvements in the states' capacity to manage to increase cost recovery (as an essential part of sector commercially enforceable contracts; (ii) an reform), broaden the base, improve the efficiency of environment conducive to efficient public investment taxation, and ensure tax harmronization across states. in areas where the public sector will remain important Some states have already taken significant steps in this such as roads and urban services; (iii) public direction, but much remains to be done. expenditure restructuring (such as privatization, freeze  Executive Summary vii Policy Priorities percent of GDP for the past few years, of which consolidated central and state governments deficit 26. India's overarching development objective amounts to 6.8 percent of GDP at present. Yet, it is during its Ninth Plan period (1997-02) is achieving and only with a more rapid decline in fiscal imbalances that sustaining high annual rates of growth of 7-8 percent the high real interest rates that have prevailed in the and ensuring that this growth benefits the poor. A recent past will decline. A target of 4 percent of GDP broad consensus has emerged across India's political for the consolidated central and state governments spectrum for this objective and for continuing the deficit may be a realistic goal to achieve in the next 3-4 liberalization of the economy. At what speed this will years. Reducing central and state governments be done remains however an unresolved--yet critical-- subsidies on "non-merit goods" which absorb 11 issue because it will determnine the country's growth percent of GDP at present could provide the resources performance. needed to reach, and perhaps exceed, this target. A more rapid privatization of public enterprises would 27. The rapid growth of the last few years has enable the government to retire public debt and reduce shown how much India stands to gain from interest costs. The benefits of a more rapid correction deregulation and fiscal adjustment. It has also shown of fiscal imbalances go well beyond just lower interest that the economy is facing capacity constraints, most rates and higher investment. Lower fiscal deficits and notably in infrastructure. High real interest rates are interest rates would provide favorable conditions for an another indication of stress on domestic resources acceleration of banking reform, would help improve which has been at the origin of pressures put on the the health of the financial system, would provide more authorities to accelerate, perhaps prematurely, the flexibility to the RBI in the conduct of monetary opening of the capital account--a development that in policy, would reduce pressure for opening the capital all circumstances would need to be carefully account ahead of the structural reforms needed to make synchronized with India's progress in structural it a success, and would make it easier to manage surges reforms. Resources are also being strained in in capital inflows, and possible external shocks. agriculture which has grown dependent on extremely International experience shows that a strong fiscal large subsidies (power, water, fertilizer, to name just position has a central role in managing effectively the the main ones). These subsidies put an unsustainably capital and current accounts of the balance of large burden on central and state government budgets, payments. and also are at the origin of microeconomic distortions and misuse of resources (of which overexploitation of 29. Also, as highlighted in the May 1997 groundwater resources and poor energy conservation government paper on subsidies, central and state policies are two important examples) which reduce government deficits are linked to significant productivity growth. microeconomic distortions whose cost they bear. Again in this case, the benefits of fiscal corrections go beyond 28. The centrality of fiscal adjustment. As it has improve, the maeroeeon o beyond forthepas sverl yar, rducng nda'sfisal improvements in the macroeconomic framework-- for the past several years, reducing India's fiscal because they are tantamount to correcting severe price imbalances remains of central importance for the distortions and misguided sector policies which are achievement of the country's development goals. preventing private investment and hampering While gains have been made in reducing the central development. Power is one well known case where the government fiscal deficit, those have been offset in the correction of price distortions would not only reduce recent past by a deterioration in the financial position state governments fiscal imbalances (by 2 percent of of public enterprises, mostly because of the large cost GDP), but would also lead to a more efficient use of (0.8 percent of GDP in 1996-97) of subsidizing oil resources, and provide the basis for private capital in products. As a result, the consolidated public sector power and the much needed capacity expansion. deficit has remained at the relatively high level of 9 Similar situations exist in other sectors.  viii Executive Summary 30. In addition to the macro-and micro-economic 33. At the same time, to support agricultural dimensions of fiscal adjustment, a third, and at least as reforms, it would be essential to bring rural credit important one, is that of expenditure composition, reform to its logical conclusion. A coherent strategy for particularly at the level of the states. In most states, the increasing flows to agriculture and other rural cost of subsidies, of an excessively large labor force, economic -activities must address issues of access to and of government activities which are not of a financial services by the rural population in general, as development nature absorb a large share of state well as the financial sustainability of the rural financial governments budgets. To a large extent, the institutions themselves. Further measures are needed deterioration of India's infrastructure, and the to encourage and facilitate an orderly re-orientation of difficulties the country is experiencing to mobilize India's rural financial system from the supply-led resources to accelerate the development of its human approach of concessional, targeted agriculture credit, to resources are the result of states' pricing and sectoral the systematic development of demand-oriented rural policies and the associated implied subsidies--and it is financial markets. also with the states that lies their resolution. Recent declines in central government financial support to the 34. Deregulating agriculture. Deregulation would states have provided some--but as yet insufficient-- enable agriculture to achieve potentially large impetus to the states to start taking corrective actions. efficiency gains and provide a basis for the removal of subsidies. The 1997-98 Budget contains the first steps 31. Addressing the challenge of infrastructure. of a promising beginning of reforms at the level of the Much has been said and written on India's central government, which could provide impetus-- infrastructure problems. The recently completed report although it has not thus far--for similar reforms at the of an Expert Group on infrastructure provides a level of the states. Intimately related to the sobering review of India's tremendous infrastructure liberalization of agriculture is the deregulation of agro- problems and makes three recommendations to address industry where important segments are still regulated them. Thefirst is fiscal reforms to strengthen state and by industrial licenses or scale limitations that impose local governments capacity to mobilize resources to large costs to an industry characterized by economies invest in infrastructure. This is particularly important of scale. Because the incomes of the poor are so for infrastructure of a public nature where benefits are closely associated with the fortunes of the agricultural best captured through taxation. The second is sector, a liberalization of agriculture would not only regulatory and pricing reforms to translate India's have positive growth effects, it would also help immense infrastructure needs into viable commercial increase the incomes of the pooir. ventures, capable of attracting private capital. The third is financial sector reforms to enable the large 35. Completing the liberalization of the trade and pool of India's financial savings to flow to high returns investment regimes remains an important policy infrastructure investments. objective. India's import-weighted tariff has been reduced from 87 percent in 1991-92 to around 20 32. Banking reforms. Further banking and financial percent at present. The 1997-98 budget indicates that deregulation (reducing government equity in the the process will continue, until India reaches the tariff capital of public banks and further reductions in the levels of its East Asian neighbors. There are also SLR) would reduce the influence of government on indications that the government intends to eliminate commercial banks' basic business decisions (such as restrictions on consumer goods in a phased manner. on hiring, on pay scales, branch expansion or closure), Implementation of this agenda would improve and permit more vigorous competition from private considerably the competitiveness of India's banks. The RBI is gradually strengthening its oversight manufacturing, as would a further deregulation of the capabilities, and this provides the basis for a further investment regime. The radical liberalization of the last deregulation of the banking system. six years notwithstanding, extremely costly regulations  Executive Summary ix continue to restrict investment in areas reserved for private sector shows strong interest in investing in a small scale and agro-industries. number of infrastructure areas, particularly power and telecommunications, an important role remains for 36. A prudent management of tlhe capital account public sector investment in some key areas--such as remains appropriate until fiscal consolidation has been roads, rural infrastructure and social services--which achieved, the instruments and markets for indirect would need to be substantially increased. Such monetary control are more fully developed, the investments are crucial for sustaining rapid growth and commercial banking system is strengthened, trade ensuring that the poor participate in the growth liberalization is complete and exports sufficiently process. diversified. Consistent with this objective, the pace of liberalization of restrictions on debt-related capital and 38. The Bank therefore recommends that the short-term capital would need to be gradual, tailored to members of the IDF should aim for official the pace of fiscal consolidation, progress in development assistance that directly supports priority strengthening the domestic financial system, and public investments in physical infrastructure and export performance. Priority would be given to human capital development. This investment would meeting the needs of long-term infrastructure financing also help crowd-in the necessary complementary as the government has indicated in its 1997-98 private investment particularly in physical External Commercial Borrowing guidelines. infrastructure. In addition to the financial flows, Otherwise, there would be a danger of prompting official development assistance is also crucial to build volatile financial conditions and sharp cross-border institutional capacity particularly at the level of the surges in short-term funds that would be difficult to state and local governments. Therefore, as had last manage and could put serious stress on the domestic year's CEM, this report makes a case for India's banking system. continued access to long-termn assistance, including a substantial concessional component. In view of its still Externalfinancing requirements current high debt burden, India would need to continue to prudently manage its external debt. With an 37. India will continue to need to rely on official topuelymngisexmadb.Wth n 37.elopIndiaswilotinue, notoithaneedigtorel goffica expected modest current account deficit of 2 percent of development assistance, notwithstanding the growing GPoe h etfwyasadtencsaybid role of private inflows. Besides India's low level of per uP oferve ndia would til reqetoalygross capia GP (U$35), ofical evelpmet asistnce up of reserves, India would still require total gross capita GDP (US$350), official development assistance fiacnoflsetUS1ilonn1979,ndn is also critically necessary for India to meet its average of about US$17 billion in each of the enormous needs for infrastructure and human resource foloig four yS. bilatera an multilate development. As indicated in the Poverty Assessment particint atls years IiaDelopmentFram Report, distributed to members of India Development patcanstlstyr'IdiDelomtFru Report,IF dIsibut toversy ofmn widiDevpmeaant pledged about US$6.7 billion in official assistance to Fou ID) ndaspoet rmis iepra n India's development efforts as a recognition of India's the lives of many of India's more than 300 million commioment tofreforms n neto aceeate poor are burdened by poor health, illiteracy, and social ' ' ~~~~growth and reduce poverty and a similar amount is inequalities. Prospects for improving their standards of expeted rethis yert and non-debt commeria living depend on India's ability to promote growth and sources are expected to account for the country's invest in human resources development. While the remaining financing needs.  I  Chapter RECENT ECONOMIC DEVELOPMENTS 1.1 A number of reports issued in 1996-97 (the A. Recent Economic Developments Ministry of Finance's Economic Survey; the Reserve Bank of India's (RBI) Annual Report; the RBI Report A strong supply response on Currency and Finance; the RBI Report on Trend and Progress of Banking in India; the India 1.2 The reforms of the past six years brought Development Report (IGIDR); the government about an unprecedented strong economic appointed Expert Group Report on Infrastructure; the performance. After growing at over 5 percent in 1992- 1997-98 Budget speech; the RBI April Credit Policy; 93 and 6 percent in 1993-94, preliminary estimates and the May 1997 Ministry of Finance's discussion suggest that real GDP grew at close to 7 percent for the paper on government subsidies) document third year in a row in the fiscal year ending March 31, comprehensively India's past and recent performance, 1997 (Figure 1.1). A good monsoon (agricultural articulate the governments' development objectives, output grew by 3.7 percent in 1996-97, led by and provide an accurate picture of the policy continued record growth levels of commercial crops-- challenges the country faces. Because of the particularly oilseeds and cotton) offset the impact of comprehensiveness and depth of this documentation to slower industrial growth, from 11.6 percent in 1995-96 which interested readers are referred to, this report to 7.5 percent in 1996-97 (Annex, Table 1). However, comments only on salient recent economic and policy data made available after the CSO published its developments. A poverty assessment issued as a preliminary estimates for 1996-97, suggest that the companion to this report discusses India's progress in decline in the growth rate of industrial production human resource development and poverty alleviation might be more pronounced than initially expected, thus over the last fifty years. leading to a lower 1996-97 GDP growth. Figure 1.1: Economic Growth 16 0-;-. 1 4.0 12.0 - 10.0 50 8.0 i i -4.0 - i I ' ~~GDP at Factor Cost ---Agriculture - - Industiy - - - Manufacturing L_______ Services Source: CS0.  2 Chapter 1. Recent Economic Developments 1.3 The slowdown of industrial growth was due to in the last few years, respectively 24 percent of GDP production shortfalls of crude oil (following steadily and 18 percent of GDP in 1995-96 (Figures 1.3 and declining output from Bombay High and Neelam 1.4), and that may explain times series analysis fields, and sluggish implementation of enhanced suggesting that India's long-term growth path is now recovery programs) and power (production grew by around 6 percent, compared to 4 percent in the period only 3.4 percent against a 10 percent rise in demand, preceding the 1991 reforms. reflecting inadequate levels of investment in the sector). Within manufacturing, the capital goods Fiscal developments remain a serious concern industry benefited from tariff cuts on essential inputs and experienced a strong recovery in 1995-96 and 1.5 Preliminary estimates indicate that the central 1996-97--although more recent indicators suggest that government has met its fiscal deficit target of 5 percent the recovery may be tapering off (Figure 1.2, Annex, of GDP for 1996-97. This was achieved not only as a Table 2). share of GDP, but also in nominal rupees (with a fall in the primary deficit from 0.9 percent of GDP in 1995- 96 to 0.4 percent) (Annex, Table 4). This outcome Figure 1.2: Trends in Manufacturing Growth occurred despite large shortfalls in privatization 30.11 L proceeds (0.4 percent of GIDP) and corporate tax 20A ~~~~~~~~~~receipts (0.1 percent of GDP) as well as an overrun in MO ,,,,, 15defense spending (0.3 percent of GDP). This was (0 ~~~~~~~~~offset by delays in the implementation of the ;,,,, iM, X e iii ,7- recommendations of the Fifth Pay Commission for -150 =l S Swhich 0.3 percent of GDP had been allocated, by --Capital (loads Consomcr (loads - . - .savings in interest payments (0.2 percent of GDP), and e-CopitalGoods-ConnuncrOood--Ocalde * ApdI-Ioooc by a slight increase in income tax collections and lower C,os CSOand Econotic Sun 1997 than budgeted spending on education and nutrition (mostly on account of the nlid-day meal program) Strong saving and investment performance which provided the remaining 0.3 percent of GDP. 1.4 Contrary to India's previous experiences, this expansion is not putting pressure on inflation or the external accounts. Higher investment (26 percent of Figure 1.4: Gross Domiestic Investment GDP in 1996-97) has been financed by national 20.0 savings (25 percent of GDP)--rising mainly on account a 2 o 7 7 7fl0 of the good performance of private savings. Public % 10.0 l U Public sector savings remained low as a result of the poor financial a 50 III 1I I 0 Privatesector performance from center and states governments and o.0 :Privat e seoL 0.0 public enterprises (Figure 1.3, Annex, Table 3). Private .