Statement by Olivier Bourges at the Board meeting of January 15, 1998

International Bank for Reconstruction and Development International Development Association 86758 International Finance Corportation Multilateral Investment Guarantee Agency FOR OFFICIAL USE ONLY CONFIDENTIAL EDS98-6 January 14, 1998 Board Meeting of Januarv 15, 1998 Statement bv Olivier Bourges INDIA - COUNTRY ASSISTANCESTRATEGY I welcome this candid and well-designed staff document that provides an adequately a focused strategy for the Bank in India over the coming years in the framework of momentum will be a strengthened partnership. Maintaining a strong and sustainable growth major challenge in order to achieve progress on poverty reduction. Through further improvements in the quality of its services, the Bank should help the Indian authorities address of the economic constraints and the various other obstacles that recentlv led to the weakening our portfolio performance. J CHALLENGES MACROECONOMIC The spread of financial instability in East Asia obviously has raised concerns on India's economy which was already experiencing a slowdown. While its external short-term vulnerability is relatively low, India's competitiveness is likely to be affected by the consequences of strongly depreciated Asian currencies; this may even have been the case over the last months. Against this background, it appears all the more urgent to establish macroeconomic conditions conducive to sustainable, private sector-led growth Todav, this requires a "second wave" of structural reforms. Strong action seems particularly urgent in two areas: * Fiscal reform Fiscal uncertainties remain the main threat to macroeconomic stability. Recurrent fiscal deficits have induced long-term crowding out of private investment via high real interest rates. I am thus concerned by staff forecast, under the "base case" lending scenario, that the central government deficit would remain at about 4.5% of GDP in 1999/2000 Since the states seem to adjust less than the central government, this would mean the overall public deficit would stay above 8% of GDP through the end of the decade. It is difficult to find satisfactory such an objective, particularly in view of the urgent need to promote private sector development. The Bank could be involved more significantly in the design of an adequate fiscal This documenthas a restricteddistribution and may be used by recipientsonly in the performance may not otherwise of theirofficialduties. Its contents be disclosedwithout WorldBankauthorization.  2 strategy by helping to improve the level and structure of public expenditures. In particular, subsidies, both at the federal and at the state levels, today appear to be a source of high public resources waste and of important economic distortions. This is reflected in the WA'hite Book published last vear in India, which estimated that so-called "nonmerit subsidies" --as opposed to those which have clear direct economic or social justification-- amount to about I 1% of GDP. This area should remain a priority for further reform. and I encourage the Bank to candidly address this issue in the policy dialogue with Indian authorities. 0 Btusinessenvironment More generally, private sector-led growth in India will require decisive improvements in the business environment. FDI inflows are notably insufficient in view of India's economic size and potential. India is still in many respects a protectionist country where various distortions both on the domestic and on the external front prevent a rapid build-up in investor confidence. The comprehensive IBRD/IFC strategy is welcome in this respect. since the reform agenda is broad and action with greater resolve is needed in many areas. Apart from the need for upgraded infrastructures, staff correctly and thoroughly outline the main issues to be addressed, including trade liberalization, the regulatory framework or improved governance --corruption, transparency. In this respect, it seems pertinent that the Bank's guidelines on corruption should also be applied on a state-by-state basis to determine, when needed, our lending program. I would also appreciate more details from staff on the actual situation of the public banking sector, as interventionism in this sector is another important feature of the Indian economy. Staff mention a figure of 7% of non-performing loans. I would appreciate very much their comments on the reliability of this figure. In particular, it seems to me critical that Bank accounts comply with international banking accounting standards More generally, further details on the strategy envisaged by the Bank in this sector would be welcome. 1J BANK'S SELECTIVITY Increasing the Bank's role in India, mainly through a new IBRD lending strategy. is a welcome prospect. However, the resources that the Bank can dedicate to India are limited compared to the size of the challenges. Accordingly, we fully endorse focusing our strategy in areas where a constructive policy dialogue gives our support a major catalytic effect. Maximizing our leverage, it is also likely to contribute to marked improvements in the performance of our portfolio. Given the increasing responsibility of states for their own development policy decisions, privileging the states whose level of commitment to reforn will improve the impact of our support is fully consistent with our selectivity objective --along the lines indicated by staff in paragraph 32, page 9. Likewise, I welcome the design of triggers for new IBRD commitments, which involve a combination of conditions both at the national and at the state  3 levels. This being said, the selective approach envisaged also raises some questions - it requires a cautious timing of our lending program in India. state concentration should be taken into account from the very beyinning, since it could in the future prevent us from responding with sufficient flexibility to requests from states which commit to reforms at a later stage, - as briefly indicated by staff, priorities regarding poverty alleviation are likely not to perfectly match the selection of states according to their commitment to reforml. Could staff give more details regarding to what extent they intended to offset the disadvantages of this strategy with respect to our overarching objective? - finally, the selective approach is potentially very challenging both in terms of financial commitment and of our capacity to deliver consistent and long-term high-qualitv expertise: are staff and Management reasonably confident in the Bank's means to realize this strategy in a cost-effective manner? O BANK' S INSTRUMENTS 3 IBRD/IDA blend I welcome the expected hardening of the IBRD/IDA blend under the proposed lending program. Nevertheless, I am concerned by the risk that in situations where IBRD operations would have to be significantly scaled down, IDA allocations would be proportionally far less reduced. In this respect. I have some difficulty reconciling: (i) the proposal to cease new lending commitments in cases where states pursue policies opposed to desirable reforms --paragraph 32, page 9--, with (ii) at the same time, maintaining IDA core programs --paragraph 64, page 18. It seems to me that there is a potential contradiction between the two proposals. In the case where all the states would pursue adverse policies, the rationale would then be to cease our lending programs, as proposed in paragraph 32 The only acceptable exception would be to have IDA core programs fullv immune to deteriorations in the policy environment. * Local costs On the whole, I would recommend halting the financing of local costs or, at the very least, setting a low ceiling. India has no major difficultyin financing its current account deficit, and we do not see many reasons why local costs should be financed by borrowing in hard currencies. This would not be a long-lasting solution to the problem that "sustailable funding for human development is still a crucial issue" in India. Indeed, our catalytic role should also target the creation of incentives for increased commitment from the Indian side to achieve fiscal adjustment and to devote resources to meet the country's long-term social challenges.  4 Furthermore, according to the relevant operational policy. financini- local costs must be exceptional and the ceiling for Bank's participation must be precisely set in the CAS. In its analysis, the Bank must stick to a consolidated assessment of the capacity of the Indian authorities to fund their projects. If local governments have less ability to gtenerate internal financing revenues, cross-transfers should be considered. In the present case. risks are particularly higlhin view of the unstable foreign exchange markets in Asia. whichlcould lead to unexpected and adverse movements of the rupee. *