The challenges of India‘s economic policy

September 2014 / No. 16

Macroeconomics and Development

Introduction Over the 1990s and 2000s, India experienced a remarkable acceleration in its rate of economic growth comparable in the mid-2000s to that of its neighbour China. This economic “take-off”, which was partly driven by private investment, was anchored in the country’s strong positioning on different business sectors (chemicals/pharmaceu­ ticals, jewellery, oil refining , IT services, business services, etc.). Coupled with the launching of major social programmes, these high-growth years helped to reduce extreme poverty and foster the emergence of a middle class.

Yet, the outbreak of the 2008 financial crisis seems to mark a turning point for the Indian economy. Once the supportive effects of the 2009 fiscal and monetary easing had passed, economic activity has been progressing at an average pace of 5% (year-on-year) since 2012/2013. While the ongoing normalisation of international financial conditions and the global economic slowdown have played a part in this recent downturn of India’s economic performance, its root cause lies above all in internal factors that are mostly structural. The onset of macroeconomic imbalances during the 2000s (twin deficits, inflationary pressures) has obliged the country’s public authorities to adopt a growth-constraining “policy mix” since 2010/2011 (increase of key interest rates; slowdown in public spending). But, more importantly, these imbalances have revealed the extent of factors limiting supply-side capacities

The challenges of India’s economic policy Vincent Caupin Stéphanie Pamies-Sumner Macroeconomic Analysis and Country Risk Division, AFD caupinv @ afd.fr

that India now has to address, if it wishes to pursue the momentum towards convergence with the more advanced economies begun in the mid1990s. These supply-side constraints comprise d ef i c i t s i n p hy s i c a l i nf ra st r u c t u re ( e n e rg y, transport, storage) and human capital (education, training), as well as the quality of the country’s governance.

Several studies offer a more mixed view of India’s economic performance over these two decades of high growth: according to Drèze and Sen (2013), progress in human development remains slow in light of the marked increase of gross domestic product (GDP) per capita, in this vast country where nearly 70% of the population still survives on less than 2 dollars (USD) a day (at purchasing p owe r p a r i ty – P P P ) . D e s a i e t a l . ( 2 0 10 ) a n d P i ketty (2013) show the persistence, and even increase, of social inequality. In fact, this lack of inclusiveness in economic growth, stemming

Table of Contents primarily from insufficient capacity to create jobs that m atch a m o st l y u n s k i l l e d wo rkfo rce , p re s e nt s a challenge to the Indian growth “model”. So far the structural change in India’s productive fabric has involved a shift from the agricultural to the services sector (McMillan and Rodrick, 2011), but the “world’s office” (Boillot, 2009) now plans to speed up its industrialisation (Planning Commission, 2013).

Wearied by a political decision-making process judged to be excessively long and complex and by the increasing number of large-scale corruption scandals in recent years, the “world’s largest democracy” has chosen a political response to these economic and social ills. The general elections in May 2014 marked a watershed in Indian political life: as an opposition party, the Bharatiya Janata Party (BJP, the Indian People’s Party ), came into power in a system that had been mostly dominated by the Congress Party since India’s independence; they also put an end to a system of broad coalition governments that had become virtually systematic since the 1990s. Improved political efficiency, the fight against corruption, the return of Shining India (a concept first popularised by the BJP in the 2004 elections), are the main lines of the agenda set by the new Indian Government. At a time this new mandate is in its early days, this paper proposes to give an update on India’s macroeconomic situation and the main challenges facing economic policy in the upcoming years.

1 / THE PACE OF ECONOMIC GROWTH ACCELERATES MARKEDLY UNTIL THE 2008 GLOBAL FINANCIAL CRISIS

3

1.1. India’s steadily accelerating economic growth

3

1.2. The role of economic reforms in the 1980s

and 1990s

4

1.3. Investment robustness and structural

transformation in the 2000s

5

2 / DISAPPOINTING SOCIAL PERFORMANCES

AND AN INCREASINGLY FRAGILE POLITICAL ENVIRONMENT

10

2.1. A country where poverty and inequality

are still widespread, despite some recent progress

10

2.2. A more fragile political environment

14

3 / THE CHALLENGES FOR ECONOMIC

POLICY ARE MANY ON THE ROAD AHEAD

20

3.1. Growth: ease supply-side constraints

and increase the job-creation potential

of growth

20

3.2. Public finance: expanding fiscal space

28

3.3 External accounts: reducing energy

dependence and improving the quality

of external financing

39

CONCLUSION 48

2

ACRONYMS AND ABBREVIATIONS

49

REFERENCES

50

© AFD / Macroeconomics and Development / September 2014

1/ The pace of economic growth accelerates markedly until the 2008 global financial crisis 1.1. India’s steadily accelerating economic

growth

India has experienced a steady acceleration in its pace of growth since the 1980s. While the average annual rate of growth did not exceed 3% in the 1970s (a relatively low rate considering the country’s level of development, and referred to as the “Hindu rate of growth”), it reached 6% in the 1990s and even accelerated to an average annual rate of nearly 8% as from 2003/2004 (cf. Figure 1). Internationally, this growth rate ranks India among the twenty countries with the highest economic growth during the 2000s, and among the front-runners, along with China, if oil-

producing countries or countries in a post-crisis reconstruction/conflict phase are excluded (Cottet, 2011). Although this relatively strong growth has expedited the convergence of India’s economy with the global average in terms of GDP per capita (measured at constant prices and purchasing power parity), its performance remains well below the ground-gaining catch-up seen in China (cf. Figure 2). Finally, economic growth in India is characterised by its relative stability (especially compared with other emerging countries): it has not been in recession since the 1980s, was not affected by the 1997 Asian crisis and weathered, initially at least, the 2008 financial crisis (Chaponnière, 2014).

Graphique 1 Figure

Graphique 2 Figure

Steady rise in the pace of growth since the 1980s

India’s economic take-off weaker than in other Asian countries

(GDP growth at constant prices, factor cost)

(real GDP growth, log [index = 100 to date t, which corresponds to the year of take-off])

■ Growth rate

Japan (1955+) Indonesia (1973+) India (1995+)

10-year average

12 10

South Korea (1967+) China (1979+)

1,6

8 6

1,4

4

1,2

2

1,0

0

0,8

-2

0,6

-4 -6

0,4

Last plot: FY 2013 (2012/2013) FY12

FY07

FY02

FY97

FY92

FY87

FY82

FY77

FY72

FY67

FY62

FY57

FY52

-8

0,2 0,0 t

t+4

t+8

t+12 t+16 t+20 t+24 t+28 t+32 t+36 t+40

Source: Central Statistical Office (CSO).

Sources: International Monetary Fund (IMF), World Bank, Statistics Bureau Japan

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3

1.2.

The role of economic reforms

in the 1980s and 1990s

Historically, acceleration of the growth rate of India’s economy has often been linked with country’s successive waves of economic and financial liberalisation reforms that were first introduced in the 1980s (dubbed the “pro-business” reforms), then in the 1990s following the 1991 balance of payments crisis (dubbed the “pro-market” reforms). As Chaponnière (ibid.) notes, evaluating the respective impact of these reforms on growth is the subject of lively academic debate: Rodrick and Subramanian (2005) consider the 1980s reforms to be determining factors, whereas Bhagwati and Panagariya (2013) conclude that it is rather the reforms introduced from 1991 onwards that explain India’s accelerating growth. Other studies point

up the difficulty of evidencing a causal link between reform and growth (Bardhan, 2010), especially since a significant share of India’s economic “take-off” can be attributed to the traditional services sectors, or so-called “non-organised” sectors (Cottet, ibid.). These comprise very small and often informal businesses on which regulatory or commercial reforms have little direct impact (although there are likely to be indirect effects). As a result, although communication services (including IT) and financial and business services (including those linked to outsourcing) have seen a significant increase in their rate of growth since the 1980s (e.g. communication services grew at an average annual rate of 18.5% by volume between 1993 and 2002), it was trade and commerce as well as social and personal services that continued to drive much of the growth in services and GDP until the early 2000s (cf.

Figures 3 and 4).

Graphique 3 Figure

Graphique 4 Figure

Sharp acceleration of services growth since the 1980s, driven by the reallocation of labour and increased productivity…

Contrib. TFP ■ ■ Contrib. capital stock ■ Contrib. labour Growth of services VA (yearly average)

…but still largely attributable to the traditional sectors until the early 2000s (contribution of value added (VA) of services to average yearly growth, %) ■ 1951-1982

■ 1993-2002

30 25

10

Percent. Points

9 8

20 15

7 6

10

5

5

4

Note: TFP = total factor productivity (of production).

Source: Bardhan (2010).

Source: CSO, authors’ calculations.

© AFD / Macroeconomics and Development / September 2014

Railways

Communication

Hotels & restaurants

Transport (excl. railways)

1993-2004

Electricity, gas and water supply

1978-1993

Banking and insurance

1 0

Social and personal services

2

Real estate and business services

Trade & commerce

-0

3

4

■ 1983-1992

1.3. Investment robustness and structural

transformation in the 2000s

1.3.1 A sharp increase in the rate of investment boosted by improved financing conditions More recently, the 2000s saw a further acceleration in India’s economic growth that even neared 10% in 2005 and 2006, and this “paradoxically” at a time when the pace of economic reform is judged to be slower than in previous years. It is therefore necessary to look to other factors, both external and internal, to explain this “take-off”:

• The 2000s are above all marked by large capital inflows to India, peaking at USD108 billion in 2007/2008 (almost 9% of GDP compared with an average of about 2% since the mid-1980s) and driven particularly by foreign direct investment (FDI) flows and portfolio investments. This financial “exuberance” (Boillot, 2009) stemmed from both a sharp increase in international liquidity during this

period and changes in investor perceptions of India, [ 1 ] in a context of the country’s increasing trade openness and financial sector development (cf. section 3.3);

• This development, along with a sharp fall in India’s real interest rates over the period (from nearly 12% in real terms at the end of the 1990s to about 3% in 2008), helped to fuel an upsurge in the level of private corporate investment [ 2] (cf. Figure 5). This rapid increase in private corporate gross fixed capital formation (GFCF) contributed to an increase in overall investment levels from less than 24% of GDP in 2002 to over 30% of GDP as from 2005.

While this level was still lower than in China (almost 47% of GDP in 2012), it is high by international standards and grew more swiftly than the average in lower-middle-income countries (LMICs) and Southeast Asian countries. [ 3] When broken down into major demand components, GDP growth acceleration over the 2000s appears to have greatly benefited from this investment dynamic (cf. Figure 6).

Graphique 5 Figure

Graphique 6 Figure

Sharp fall in real interest rates fuelled a record rise in corporate investment

Key role of investment in recent growth

Corporate GFCF / GDP (volume) Real interest rate (av. agri., indust. & services) – RH scale (inverted values)

12

8

-2

10

-4

6 4

12

2 0

1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012

Sources: CSO, Reserve Bank of India (RBI), authors’ calculations.

14

2010-11

0

8

2007-08

2

6

2004-05

12 10

2001-02

4

4

14

1998-99

6

2

16

1995-94

0

1992-93

8

18

1983-84

-2

1989-90

10

20

1986-87

■ GFCF ■ Domestic demand (excl. GFCF) ■ External demand GDP

Source: CSO.

[ 1 ] For example, Indian sovereign risk was rated as “speculative” grade by Fitch until 2006, after which it was upgraded to “investment” grade. [ 2 ] The role of interest rates in corporate investment in India (as well as in external financing flows) has been shown notably by Jangili and Kumar (2010) and Tokuoka (2012). [ 3 ] According to World Bank data (World Development Indicators - WDI).

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5

1.3.2

Continuing India’s sectoral transformation

In addition to this capital accumulation effect, what also helped to spur India’s economic growth from the early 2000s were the beneficial effects of resource re-allocations across different sectors of the Indian economy on apparent labour productivity (McMillan and Rodrick, 2011; Oura, 2007). [ 4] In fact, in the 1980s and 1990s the declining share of agriculture in the economy advantaged both traditional services (trade and commerce, hotels and restaurants, social services in particular) and the so-called “modern” services (communication, banking and insurance, real estate and business services). However, during the 2000s, this re-allocation almost exclusively benefited “modern”

services (cf. Figure 7). This sectoral transformation mainly reflects a shift of labour (that seems to have accelerated at the end of the decade) from the agricultural sector to sectors with higher value added (cf. Figure 8 and Box 1). India’s trade openness and financial sector development, which both increased significantly during the 2000s (cf. Section 3.3), most likely also contributed to productivity growth (particularly within-sector growth in sectors exposed to foreign competition), as suggested by the IMF (2006). India’s Ministry of Finance (MoF) attributes the strong growth in services notably to large FDI inflows over the period 2000-2012 (Ministry of Finance, 2013).

Graphique 7 Figure

Graphique 8 Figure

Recent sharp increase in the share of “modern” services

Employment shifting faster towards sectors with higher value added?

(annual average variation of share in real GDP, pp)

(2004/2005 to 2011/2012) 4,5

■ Agriculture ■ Manufacturing ■ Other industries ■ Trade, bank and insurance, real estate and business services ■ Other services

3,5

Log (sector prod./agri. prod.)

1,0 0,8 0,6 0,4 0,2 0,0 -0,2

Banking and insurance

4,0 3,0 2,5

Transport, Communication

2,0 1,5 1,0

Manuf.

0,5

Construction

0,0

Agriculture

-0,5

-0,4

Real estate and business services

-1,0

-0,6

-4

-0,8

-2

0

2

4

6

8

10

12

Average annual job growth (%)

-1,0 1951-1982

1983-1992

Sources: CSO, authors’ calculations.

1993-2002

2003-2012

Note: the size of the circles is proportional to the share of each sector in total employment in 2011/2012.

Sources: CSO, National Sample Survey Office (NSSO), authors’ calculations.

[4 ] G rowth in output per capita can traditionally be broken down into apparent labour productivity growth, labour market participation and the proportion of the working age population (inverse dependency ratio); labour productivity growth is a function of growth in physical capital stock, human capital and total factor productivity. Since the work of McMillan and Rodrick (2011) in particular, special attention has also been paid to breaking down apparent labour productivity into within-sector productivity and between-sector labour re-allocation, i.e. to structural effects.

6

© AFD / Macroeconomics and Development / September 2014

Box

2

Employment and Unemployment Survey 2011-2012: accelerating sectoral shifts in India?

India’s National Sample Survey Office (NSSO) conducts a broad employment survey, usually at 5-year intervals, which feeds into the revision of national accounts. The latest surveys cover the periods 1999-2000, 2004-2005 and 2009-2010. However, given the singular years of the 2008-2009 financial crisis together with the very disappointing employment results from the 2009-2010 survey round (Shaw, 2013), it was decided exceptionally to conduct an employment survey for the period 20112012.

Historically, sectoral shifts in India are regarded as slow and relatively atypical compared to other countries (Binswanger-Mkhize, 2013). Although agriculture’s share in GDP has declined steeply since the late 1970s, the share of agricultural employment has decreased much more slowly. Even though demographic growth has remained relatively strong (population growth of about 1.5% per year and workforce growth of 2.8%), migration from rural to urban areas has remained limited, hindering the sectoral re-allocation of labour. A combination of insufficient low-skilled job creation – particularly in the manufacturing sector –, the prevalence of informal employment and the narrowing gap between rural and urban poverty levels has thus impaired the attractiveness of urban areas. Yet, this does not mean that sectoral shifts are not in train: the widening productivity gap (and consequently wage differential) between the agricultural and non-agricultural sectors has led rural households to diversify their activities into the rural non-farm sector, mainly construction (the proportion of rural households’ non-farm income increased from about 15% in 1999 to almost a third in 2007; Binswanger-Mkhize and D’Souza, 2011).

The results of the latest employment survey (2011-2012) are interesting on several counts:

• Whereas

job creation in industry and services over t h e p e r i o d 2 0 0 4 - 2 0 0 5 to 2 0 0 9 - 2 0 1 0 wa s ve r y disappointing (2.8 million compared with nearly 61 million over the previous 5-year period), the results of the 2011-2012 survey show an upturn in employment (with some 13 million jobs created over 2 years);

history, the proportion of people employed in agriculture fell slightly below 50% (48.9%). The accelerating decline seen in the share of agricultural employment was to the benefit of industry, particularly manufacturing and construction, as well as services, especially the so-called “modern” services (including transport, storage and communication; cf. Figure 9).

This yet-to-be-confirmed trend seems to corroborate the major contribution of these services to the acceleration in GDP growth, given their higher productivity. The gathering momentum of job creation in the manufacturing sector is also of note;

• Lastly,

the proportion of people in regular/paid employment is increasing sharply: whereas the proportion was only 15% in 1999-2000, it reached 20% of total employment in 2011-2012. Despite this upturn and the resulting fall in the unemployment rate, these figures should be viewed in the light of India’s relatively low participation in the labour market by international comparison: in 2011, participation was 55.6% (of the working age population), compared to almost 70% in Brazil and 74% in China.

Graphique 9 Figure Recent acceleration of the decreasing share of agriculture in total employment, particularly in favour of manufacturing and “modern” services (average annual variation in the proportion of total employment, % points) ■ Agriculture ■ Other industries ■ Other services

■ Manufacturing ■ Modern” services

1,0 0,5 0,0 -0,5 -1,0 -1,5 -2,0 -2,5

• They also reveal a nascent accelerating sectoral shift in

2004-1999

2009-2004

2011-2009

India’s employment. For the first time in the country’s

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7

1.3.3 The demographic dividend and NREGA programme: more ambiguous effects India’s “growth story” in the 2000s also seems to be fuelled by the favourable effects of the demographic dividend. Since the 1990s, there has been a significant decrease in the dependency ratio [ 5] (down by more than 8 percentage points over the 2000s, as in the 1990s, compared with a drop of less than 5 percentage points in the 1980s and 1970s; cf. Figure 10). Cottet (2011) notes that this demographic dividend – which generally tends to drive growth through a variety of channels (directly via an increase in the available workforce and indirectly via increased savings [ 6] and hence investment, but also through education [ 7] and hence human capital) – is considered by some authors as a key driver of India’s growth over recent decades (Aiyar and Mody, 2011). Anand et al. (2014) predict that the dependency ratio should continue to fall at the same rate (8 percentage points) until 2030, whereas in China it is expected to rise by about 7 percentage points. It should be noted, however, that this additional d e m o g ra p h i c d i v i d e n d w i l l co m e m o re f ro m t h e northern Indian states (with dependency rates above 60% and up to about 80% for the State of Bihar), since the country’s western and southern states have already reached dependency levels close to the international average (less than 50%; cf. Map 1). As Cottet (2011) points out, India’s ability to take full advantage of this demographic dividend will depend on the pace of job creation, particularly in the country’s northern states.

The expected benefits may ultimately be more indirect (via savings and education), as suggested by the MoF (Ministry of Finance, 2013).

Lastly, the more favourable developments in rural areas also certainly helped to boost India’s economic performance in the 2000s: rural households’ consumption expenditure per capita grew by almost 3% annually from 2004 – a growth rate closer to that in urban areas than was the case in the past (cf. Figure 11) and which helped to accelerate the stronger overall dynamic of final household consumption during the 2000s. This improved performance is mainly due to the relative resilience of agricultural production over that decade, despite the period being one of difficult

10 Graphique Graphique Figure Comparative dependency ratio (ratio of the population aged 0-14 and 65 and over to the proportion of population aged 15-64, %) India

China

South Asia

90 80 70 60 50 40 30 20 10 0 1960 1966

1971

1976

1981

1987

1992 1997

2002 2008

Source: WDI.

Map

1

Dependency ratio by state in 2011 (national average = 57%)

(%) ■ 34.3 - 43.2 ■ 43.2 - 49.2 ■ 49.2 - 54.0 ■ 54.0 - 60.5 ■ 60.5 - 69.2 ■ > 69.2

Jammu and kashmir Himachal Pradesh

Punjab

Arunachal Pradesh

Uttaranchal Haryana Rajastan

Sikkim

Delhi Uttar Pradesh

Assam

Bihar

Dadra and Nagar Haveli

Jharkhand West Bengal

Madhya Pradesh Chhattisgarth

Gujarat

Nagaland

Manipur Mizoram

Orissa Maharashtra Andhra Pradesh Andaman and Nicobar

Kamataka

Kerala

Puducherry Tamil Nadu

Lakshadweep

Source: 2011 Census, authors’ calculations.

[5] T he number of people younger than 15 and older than 64 over as a proportion of the working age population (aged 15-64).

[6] According to life-cycle theory, the level of savings is higher during households’ active periods.

[7] With families being able to devote more resources to each of their children.

8

LMICs

© AFD / Macroeconomics and Development / September 2014

Graphique 11 Figure climate conditions interspersed by droughts (Gulati et al., 2013). The agricultural sector benefited in particular from the trend towards enhanced terms of trade over the period, productivity gains (particularly in cottongrowing), and improved access to credit (Ministry of Finance, 2013). In addition, investment in the agricultural sector has doubled since the early 2000s.

The supportive effects of implementing the National Rural Employment Guarantee Act (NREGA) have doubtless contributed to the sound performance of the rural economy, although preliminary evaluations of this programme have shown mixed effects (cf. Box 2).

Average annual growth in household c onsumption expenditure per capita (constant 1987/1988 prices, MRP* method) ■ Rural areas ■ Urban areas 4.0% 3.5% 3.0% 2.5% 2.0% 1.5% 1.0% 0.5% 0.0%

Box

2004/1993

NREGA: how has it affected the rural economy?

2

* Mixed Reference Period.

NREGA, the law guaranteeing 100 days of wage employment annually to every rural household, was adopted in 2005. The purpose of the programme is to provide poor households with a regular income and also develop the rural economy through infrastructure construction projects (mainly dirt roads connecting villages, irrigation canals and rainwater tanks). As a universal social scheme (accessible to every poor household), it relies on decentralised implementation at the local government level (particularly the panchayats [ 8] ). NREGA’s outreach has broadened in the space of just a few years: in 2012, the programme provided 2.2 billion days of work to 50 million households, with a budget bordering on 0.5% of GDP. According to the latest employment survey, some 38% of rural households were eligible for the programme (reaching 72% in the State of Chhattisgarh).

Yet, the results of the scheme are considered as mixed (Imbert, 2013), mainly because the local authorities responsible for managing it have uneven administrative capacities. In 2011/2012, a total of almost 19% of NREGA-eligible households were unable to participate in the scheme, but in some states the proportion was as

Table

1

Authors

2011/2004 Source: NSSO.

high as 35% (in Bihar), or even close to 45% (in Maharashtra). However, in five states (Andra Pradesh, Chattisgargh, Madhya Pradesh, Rajasthan and Tamil Nadu), the household participation rate was over 40%.

The scheme’s impact in terms of consumption and poverty are very heterogeneous (cf. Table 1). From a broader perspective, NREGA’s overall effects on the rural economy are viewed as mixed: it has crowded out private-sector employment to some degree and, as a result, led to higher wages (positive for the poorest households that benefited directly, but negative for the more “comfortably-off” households with employees).

Moreover, the quality of the infrastructure built is viewed as low overall and therefore unlikely to create positive externalities for the rural economy. Finally, the scheme has generated inflationary effects (see below). All in all, given these mixed results and the high cost (especially the expenses for purchase of building materials, which represent about 30% of the total NREGA budget), some economists (especially from the World Bank) are now recommending that “simple” universal cash transfers be introduced instead, much like the programmes set up in Latin America.

Impacts of NREGA in two states State

Source: Imbert (2013).

Results

Ravi and Engler (2009) Andhra Pradesh Increase in food consumption by an average 6% (15% for the poorest) Dutta et al. (2012)

Bihar

Reduction in the poverty rate from 44% to 37%

[8] V illage councils with constitutional powers.

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9

2/ D isappointing social performances and an increasingly fragile political environment 2.1.

A country where poverty and inequality

are still widespread, despite some recent progress

Measuring poverty in India is admittedly a difficult and controversial exercise (cf. Box 3) but, whatever the calculation method used, the result shows that levels are high (about one-third of the world’s poor live in India, according to Imbert, 2013). India’s poverty level surpasses the average of the lower-middle-income countries (LMICs – to which India belongs) and the

levels seen in the other major emerging economies.

The share of population living on under $2 a day stood at 68.8% in 2010 ( i.e. over 800 million Indians) compared to an average rate of below 40% in the LMICs (close to 30% in China and South Africa, and around 10% in Brazil; cf. Figure 12). Moreover, India’s poverty rate is higher than that of other countries in the region such as Nepal or Pakistan, and relatively close to that recorded for Bangladesh, even though India has a much higher GDP per capita than these countries (twice that of Nepal and Bangladesh, for example; cf. Figure 13).

Figure 12 Graphique

Graphique Figure 13

Poverty rate (% of population)

GDP per capita (USD constant 2005, PPP) India Sri Lanka

■ USD2 a day (PPP) ■ USD1.5 a day (PPP) 90

30

4000

20

3000

10

2000

0

1000 Pakistan (2008)

5000

Sri Lanka (2010)

40

Nepal (2010)

6000

Bangladesh (2010)

50

LMICs (last plot)

7000

South Africa (2009)

60

Russia (2009)

8000

Brazil(2009)

70

China (2009)

9000

India (2010)

80

Bangladesh Pakistan

0 1980 1983 1986 1989 1992 1995 1998 2001 2004 2007 2010

Source: World Bank (WDI).

Source: World Bank (WDI).

10

China Nepal

© AFD / Macroeconomics and Development / September 2014

Box

3

Measuring poverty in India: a sensitive topic

The calculation of the official poverty rate in India is a sensitive topic, primarily because it determines entitlement to social assistance, and it has sparked a great deal of controversy in recent years (in 20112012). The official poverty headcount ratio is the proportion of the population whose expenditure or income is below a pre-defined level known as the poverty line. In developing countries, this line is most often defined relative to a typical basket of goods that are considered necessary to satisfy, at least, the population’s basic needs. In India, the official poverty line is defined by the Planning Commission:

- since 2009, a revised methodology has been used, b a s e d o n t h e g u i d e l i n e s of a n e w e x p e r t co m m i t te e set up in 2005 (Tendulkar poverty lines). This has extended the basket of goods and services taken into consideration (including access to healthcare and education) and improved the coverage of the prices indices used.

These methodological revisions raised a great deal of controversy on two counts: on the one hand, they produced an official poverty line that was below the ex t re m e p ove r t y l i n e d e f i n e d by t h e Wo rl d B a n k ( $1.17 versus $1.25 at PPP); on the other hand, their findings showed that the decline in the official poverty rate had accelerated over recent years (not only relative to previous estimates but also compared to the previous period; cf. Table 2).

- u nt i l 2 0 0 9 , e s t i m ate s we re b a s e d o n t h e recommendations made by an expert group in 1993 (Lakdawala poverty lines) and set relative to the daily consumption of calories per capita;

Table

2

Poverty rate: old and new estimates (% of population)

Authors

1993-1994 (1)

2004-2005 (2)

2009-2010 (3)

(2) / (1)

(3) / (2)

Lakdawala line (old estimates)

36.0

27.7

20.3

-8.3 pp*

-7.4 pp

Tendulkar line (new estimates)

45.5

37.9

29.9

-7.6 pp

-8.0 pp

* percentage points

Source: Panagariya and Mukim (2013).

Even though, at first sight, there appears to be less inequality in India than in similar countries (particularly compared to the LMIC average and other major emerging economies; cf. Figure 14), several factors call for this view to be put into perspective:

opposed to 33 on an expenditure basis), which is close to the level for Brazil (Desai et al., 2010); complementary research on income concentration by Piketty (2013) also confirms a high level of concentration, slightly higher than that observed in China;

• the Gini coefficient, based on the distribution of

• when poverty indicators are disaggregated, large

expenditure, tended to rise from the mid-1990s (up from 31 to 34 in 2009/2010); this upward trend was particularly noticeable in urban areas (where the coefficient was 38 in 2009/2010) right from the mid-1980s, according to the Planning Commission;

disparities appear both in terms of social groups (castes, religious groups, etc.) and geographies (regions, rural/urban areas): the (official) poverty rate for Scheduled Tribes ( adivasis ) was two and a half times higher in 2009/2010 (45.6% in 2009/2010) than that of the Forward Castes (cf. Figure 15). [ 10] The poverty rate for the State of Bihar was four times higher (53.6% in 2009/2010) than that of the State of Kerala, which suggests that spatial inequalities are even more pronounced than social inequalities.

• the expenditure-based measures of inequality are most likely underestimated; [ 9] when calculated on the basis of disposable income data for the year 2004/2005, the Gini coefficient reaches 52 (as

Mainly because wealthier households have a higher savings rate than poorer households, which means that the consumption-based Gini index generally yields more “equal” estimates than does the income-based index. [ 10] In terms of religious groups, the highest poverty levels measured in 2009/2010 were for the Buddhists (39%) and Muslims (35.5%). [ 9]

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11

Figure Graphique

14

Gini index (based on expenditure distribution): a country of moderate inequality?

40

40

30

30

20

20

10

10

0

South Africa (2009)

Brazil (2009)

LMICs (last plot))

China (2009)

Russia (2009)

India (2010)

0

Source: World Bank (WDI).

Finally, a broader analysis using multidimensional indicators shows persistent difficulties in households’ living conditions compared to other emerging economies such as China or Brazil (cf. Table 3): thus, in a context with still-limited access to health s e r v i ce s, [ 11] health indicators have significantly deteriorated. For example, almost half of children under 5 were malnourished in 2006 (compared to less than 10% in China or Brazil). Similarly, despite the increase in the primary school enrolment rate, partly thanks to the adoption of the Right of Children to Free and Compulsory Education (RTE) Act in 2009, the adult illiteracy rate is still particularly high, bordering

Standard deviation / mean States

50

Kerala

50

Bihar

60

Standard deviation / mean castes

60

Scheduled Tribes (ST)

70

Bangladesh (2010)

15

Poverty rate:* marked social and geographical disparities (%)

Forward Castes (FC)

Figure Graphique

* Official poverty rate (Tendulkar lines).

Source: Panagariya and Mukim, 2013.

on the rate for Bangladesh. Finally, other indicators reveal an inadequate delivery of basic services (especially when it comes to sanitation and financial inclusion). The relatively precarious nature of living conditions experienced by most households can also be illustrated by the size of India’s informal sector, w h i ch affe c te d 8 4% of non- ag r i c ul t ura l h ou se holds in 2009/2010. For Drèze and Sen (2013), despite relatively sustained growth over the 2000s and an increase in GDP per capita, progress on India’s development front seems all in all to have been somewhat disappointing w h e n comp a re d to t h e s i t uat i on i n count r i e s li ke B a ng l ad e s h .

[ 11] Fewer than 5% of households were covered by health insurance in 2005/2006, according to the Demographic and Health Survey (DHS). Nonetheless, this figure has since risen sharply due to the roll-out of the Rashtriya Swasthya Bima Yojana (RSBY or National Health Insurance Scheme): according to the Center for Global Development (CGDev), 34 million additional households are now covered by this scheme, which has thus pushed the coverage rate up to over 15% (the next DHS 2014-2015 is currently underway).

12

© AFD / Macroeconomics and Development / September 2014

Table

3

Cross-comparison of some development indicators (latest figures available)

■ the lowest-scoring indicator ■ the highest-scoring indicator

India

China

Bangladesh

Brazil

South Africa

Income/poverty 3 813

GDP per capita (USD PPP) Poverty rate (at USD1.5/day, %)

9 083

1 851

11 716

33 12 43

11 255

6 14

Human Development Index (HDI, ranking out of 195 countries) 136 101 146 85 121 Informal employment (% of total, excl. agriculture)

84 33 nd 42 33

Health Life expectancy at birth (years)

66 75 70 73 55

Infant mortality (per 1,000 live births)

44 12 33 13 33 200 37 240 56 300

Maternal mortality (per 100,000 live births) Child malnutrition (% of children under 5) weight for age

44 3 37 2

9

Education School enrolment rate, primary (% net)

93 87* 92

93

Literacy rate (% of adult total)

37 5 42 10

85 7

Gender Gender parity index, primary school (F/M)

0.97 1.04 1.04 1.00 0.96

Primary enrolment rate, female (net)

84**

87*

93

95

84

Access to basic services Improved water source (% pop. with access)

92 92 83 97 92

Improved sanitation facilities (% pop. with access)

35 65 55 81 74

Access to electricity (% of population)

75 100 47

Access to banking facilities (% of population ages 15+)

35 64 40 56 54

99

76

* 1997 ; ** 2003.

Sources: World Bank/WDI: United Nations Development Programme (UNDP); International Labour Organisation (ILO).

Although the situation in India remains challenging in terms of inequality and poverty, the boom decade of the 2000s coupled with the deployment of large-scale social programmes have had some impact on the country’s development (World Bank, 2013). Whatever the poverty indicator applied, the poverty rate seems to have declined more swiftly over the last decade than in the past. Moreover, this accelerating decline appears to be broad-based as it is visible across all social groups, and in rural areas as well as urban areas (Panagariya a n d Muk im, 2013) . I n ad d itio n , th e f ractio n of l e s s vulnerable people living on USD4 (or more) a day (i.e.

at least double the poverty line measure) has also increased to a quarter of the population as opposed to 10% in the mid-1990s (cf. Figure 16). The signs of an emerging middle class are also perceptible, although estimates of its size are fragile: according to the N at i o n a l Co u n c i l of A p p l i e d Eco n o m i c Re s e a rch (NCAER), it has more than doubled over the last decade to reach almost 13% of the total population (more conservative calculations by the Center for Global Development [CGDev] give a smaller figure of between 6 and 8%; cf. Table 4).

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13

Although regional disparities remain wide in India, recent signs of convergence (or fewer divergences) are also visible. This is particularly the case of India’s northern states, whose GDP is traditionally one of the lowest and which have accounted for almost half of the poverty reduction recorded in India since 2005 (World Bank, 2013). Among the ten states whose poverty level was higher than the national average in 2004/2005, five have experienced a higher reduction in this rate than the national average (Orissa, Bihar, Madhya Pradesh, Tripura and Maharashtra). This more favourable trend is still nascent and needs to be confirmed, but it is nonetheless noteworthy given that the states’ economic and social trajectories had been diverging since the 1970s (Chaudhuri and Ravallion, 2007).

Figure

4

Size of India’s “middle class”

% of total population

NCAER

CGDev(1)

CGDev(2)

2001/2002

5.7

2009/2010

12.8

5.9

7.7

Number of people 2009/2010 (milions)

153

69

91

Poverty lines (per day, per person)

-

-

USD8-40 PPP USD10-50 PPP USD8-50 PPP (expenditure) (income) (income)

Source: CGDev (2012).

2.2.

A more fragile political environment

16

Share of population by household expenditure level (%) ■ Rest

Table

■ 1 to 2 times the PL

2.2.1 The credibility of political institutions weakened by the management of coalition governments and frictions over the division of powers

■ Poor

100 90 80 70 60 50 40 30 20 10 0 1994

2005

2010

2012

Source: World Bank (2013).

Until the end of the 1980s, Indian political life at national level was largely dominated by the Congress Party, which repeatedly won legislative elections with a wide majority (on average, around two-thirds of the seats in the Lok Sabha [ 12] ). However, after the 1989 elections, the Congress Party’s pre-eminence began to crumble and, at the same time, a fragmentation of the national party system set in mainly along regional lines, making coalition governments virtually the rule (cf.

Table 5). The size of state parties in terms of Lok Sabha seats rose from less than an average 10% until the late 1980s to around 30% at the last four elections (cf.

Figure 17). Although the increased frequency of coalition governments is not specific to India, the Indian situation differs from other countries (Sridharan, 2008) because of the prevalence of so-called “minority” coalition governments and the very broad base underpinning these coalitions (sometimes involving over 10 parties).

[ 12] Lower House of Parliament of the People’s Chamber (see below).

14

© AFD / Macroeconomics and Development / September 2014

Table

5

Since the late 1980s, government coalitions more frequent and mandates on average shorter

Winning/majority party

Coalition

Number of (main) coalition parties

Length of office

1951

Congress (INC *)

No

-

6

1957

Congress (INC)

No

-

5

1962

Congress (INC)

No

-

5

1967

Congress (INC)

No

-

4

1971

Congress (INC)

No

-

6

Yes 1977 BLD **

(Janata Party)

4 3

1980

Congress (INC)

No

-

4

1984

Congress (INC)

No

-

5

Yes 1989 Congress (INC)

(National Front)

1991

Congress (INC)

No

Yes 1996 BJP

(United Front)

Yes

1998 BJP (National Democratic)

Alliance)

Yes

1999 BJP (National Democratic)

Alliance)

Yes

2004 Congress (INC) (United Progressive)

Alliance)

Yes

2009 Congress (INC) (United Progressive)

Alliance)

5 2 -

5

13 2 13 1

12 5

8 5

6 5

* Indian National Congress, ** Bharatiya Lok Dal. Sources: Election Commission in India; Sridharan (2008).

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15

Figure

17

Sharp growth in the size of state parties (% of seats won) Congress

BJP

Regional (state) parties

9000 8000 7000 6000 5000 4000

1 st defeat

3000

of Congress

2000 1000 0 1951

1962

1971

1980

1989

1966

1999

2009

NB: INC = Indian National Congress.

Source: Election Commission of India.

This new “coalition era”, also seen at individual state level, involves multiple stakes: the stability and credibility of political institutions, the ability of the governments in place to drive economic reform and the effectiveness of public finance management (cf. section 3). Regarding the stability of the political regime, Leroy (2011) notes that, whereas the 1990s were marked by high parliamentary instability with power alternating between successive “heteroclite formations” (the country was called to vote five times in ten years), the country regained greater political stability as from 1999. Although exercising power through coalition governments rather than a single party can be viewed as a sign of the maturity of India’s federal democracy, in practice, this fragmentation of power makes managing government coalitions a complex affair. Under the second mandate of the United Progressive Alliance (UPA) coalition, a virtual paralysis of the situation was even observed (SaintMézard, 2012), which somewhat weakened the credibility of Indian political institutions.

16

In addition to divergences between the national party and regional parties within coalitions, frictions over the division of powers between the centre and the states may also be a source of tension. In fact, the Constitution defines not only two lists of legislative powers for the centre and states respectively, but also a third and relatively broad list that corresponds to the powers shared concurrently by the two tiers of power (cf.

Table 7). Moreover, whereas the Constitution assigns strong powers to the centre, “local” powers have gradually levelled, if not reversed, the overall balance of power since the 1990s. The regional parties thus negotiate their support to the national parties in return for accommodation of local state-specific interests (Saint-Mézard, ibid.). Also, the overlapping of powers may have led to uncertainty in decision-making in some domains (for instance, the sensitive question of opening up to FDI, which has led to contradictory decisions relating to Delhi’s mass distribution sector).

What is more, Indian “federalism” has evolved towards a multi-layered system, with some powers being devolved to the “third level” (Mathew, 2005; cf. Box 4).

Even if this trend is positive in terms of adequately assigning responsibilities (in line with the subsidiarity principle), it may well create new political uncertainties (especially as this move towards decentralisation is still incomplete, cf. Box 4).

© AFD / Macroeconomics and Development / September 2014

Box

4

Division of powers in India: some features compared with other federations

Fo r B ag ch i ( 2 0 0 1 ) , I n d i a ’ s p o l i t i c a l o rga n i s at i o n displays similar features to other federations, with a relatively well-balanced division of powers between the centre and states. Yet, historically, several aspects make India a country that is more unitary than first appears: there is a broad list of shared powers over w h i ch t h e ce ntral Parl i ament p revai l s, wh ilst the residuary powers not listed in the Constitution remain the prerogative of central government. Even in the states’ areas of power, the Constitution authorises central Parliament to legislate in the “national interest” with a two-thirds majority. Also, Article 356 of the Constitution authorises the President of India, on the central government’s initiative, to suspend a state’s e l e cte d gove r n ment and transfer i ts p rerogative s directly to the State Governor (the “President’s Rule”).

Lastly, beyond the constitutional aspect, economic p o l i c y p rac t i ce s , p a r t i c u l a rl y t h e ro l e p l aye d by t h e Planning Commission, which is an institution attached to the central executive, has given the Indian political system its relatively centralised character, at least until the 1990s.

However, a rebalancing in favour of the states – and even of a “third tier” of governance – seems to have gradually emerged in India from the 1990s onward: the role of the Planning Commission has become less constraining (since 1991, it has acted mostly as an advisory body), as is shown by the rise in unplanned public expenditure. The suppression of the widespread

Table

6

industrial licensing system (Cottet, 2011) has also increased the states’ capacity to conduct their own industrial policies. Moreover, amendments introduced in 1992-1993 recognised the role of smaller units (the “third tier”) in democratic governance: the rural area panchayats and the municipalities in urban areas (to which 29 and 18 functions respectively have been devolved; Rao, 2005). Finally, in 1994, a Supreme Court ruling set limits on the unjustified use of the President’s Rule. According to Kelkar (2010), this is a sign of the vitality of India’s federalism: whereas the United States Constitution has been amended only 27 times in over 200 years of existence, the Indian Constitution has been amended 98 times (until 2013) in about 60 years of existence!

Despite these developments, the states’ effective p owe r re m a i n s co n st ra i n e d by t h e i r f i n a n c i a l dependency on the centre (large amounts of transfers from the centre to the states; the impossibility of contracting external debt and the need for the centre’s a p p rova l fo r i nte r n a l b o r row i n g ) . M o re ove r, t h e devolution of powers to the “third tier” is incomplete and varies from state to state: the functions devolved on paper to some 250,000 local rural and urban institutions are concurrent with the centre (shared functions) and in practice the level of effective transfer of resources and associated expenditure differs greatly from one state to another.

Excerpt of the division of powers between Central Government and State Governments

Union powers (96 areas) including

Concurrent powers (52 areas) including

State powers (61 areas)* including

Defence

Law and order (police)

Economic and social planning

External affairs

Agriculture and fishing

Higher education

External trade Primary and secondary education

Trades unions and industrial disputes

Currency and bank regulation

Public health

Price control

Transport

Water and irrigation

Electricity

Land taxes; sales taxes (excl. inter-state trade)

-

Revenues include Individual and corporate income tax (excl. agricultural income); customs duties; excise taxes (excl. liquor)

* Note that these powers are shared with “local authorities”.

Source: Varshney (2013).

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17

2.2.2 Political institutions also undermined by serious corruption scandals According to Transparency International, the level of perceived corruption in India’s public sector is relatively high (the country ranked 94th out of 177 countries in 2013), although less severe than in other countries in the region (Pakistan, Bangladesh, Indonesia). While corruption is not a new phenomenon in India, it nonetheless seems to have worsened in recent years (Saint-Mézard, 2012). The corruption observed in India spans various dimensions. First of all are the “petty corruption” that adversely impacts households and corruption in the business world (Ernst and Young , 2013). Yet, recent corruption scandals have also involved larger-scale affairs in which political spheres at both central and local level are implicated: the corruption cases reported in the media concerning the 2G licenses at the end of 2010, the Commonwealth Games in 2011, and the coal-mining permits in 2012 exposed by the Comptroller and Auditor General (CAG); large-scale leakages from major social programmes implemented in India during the 2000s (cf. Planning Commission, 2005, on the Public D istribution Syste m [P DS ] ; Im bert, 2 0 13, on t h e M a h at m a G a n d h i N at i o n a l Ru ra l E m p l oy m e nt Guarantee Act [MG-NREGA]; Plannning Commission, 2011, on the Supplementary Nutrition Programme [SNP]). This relatively high level of corruption can be explained by different factors, such as administrative complexity (mainly with respect to taxation and authorisations), the overlapping and “weakness” of some political institutions chiefly at local level and, finally, the fact that the population is still very largely excluded from the formal economy (see above), with a particularly low level of financial inclusion (according to the World Bank, in 2011 only 4% of people aged over 15 received social aid through an official bank account).

This corruption has sparked reactions from civil society, at least in urban areas: this is the case in Delhi, where the latest 2013 regional elections saw the emergence of a new anti-corruption party (Aam Aadmi Party [AAP], translated as the “common man’s party”). The fact that these corruption cases have been brought into the open should also be viewed as proof of the vitality of India’s democratic system and a necessary step towards the adoption of measures to reduce them.

This has driven various policy decisions, such as the adoption of the 2005 Right to Information Act and the 2012 Companies Bill to combat corporate corruption; the creation of an anti-corruption agency (through the Lokpal Bill passed at the end of 2013); the Right to Public Services Act gradually being implemented in different states. Yet, although strengthening the anticorruption legislative framework is a significant step forward, the extent of its impact will depend on its effective application. The roll-out of a biometric Unique Identification (UID) system (Aadhaar) launched in 2010 could also help to reduce the leakages associated with social benefits. [ 13]

2.2.3 Yet democracy remains firmly anchored Democratic governance has been anchored in India for over sixty years. The Federal Republic of India was founded in 1950, three years after the country’s independence, by a constitution that is still in force today. In particular, it defines India as a “Union of States” and as specified in its preamble “… constitute India into a sovereign socialist secular democratic republic…”. Made up of twenty-nine states and seven territories, India’s political institutions were modelled on the British parliamentary system (Westminster system): the Cabinet, which exercises executive power, is headed by a Prime Minister appointed from the party or coalition with a majority in the lower house of Parliament, otherwise known as the People’s Chamber (Lok Sabha), to which it is accountable. The representatives of this Chamber are elected, in principle every five years, by direct universal suffrage. Since 1951, India has held sixteen national parliamentary elections with a relatively stable and high voter turnout rate (nearly 60%; cf. Figure 18), although this is lower than that of other emerging economies whose democratic regime is more recent (cf. Figure 19). As for the states – which have a similar political organisation to the centre – voter turnout in the (state) legislative elections appears to be higher than the rate for national elections.

Even though the Congress Party, which is the oldest Indian political formation founded in 1885, dominates the country’s political life, alternation of political power is a reality in India as other parties have held power at national level on five occasions. At state level, political changeovers occurred earlier (in 1967 as opposed to 1977 at the national level).

[ 13] Given the population size, coverage by this scheme will only be completed in 2018.

18

© AFD / Macroeconomics and Development / September 2014

Figure

18

Figure

A relatively stable voter turnout rate for national legislative elections (%)

19

Voter turnout rate similar to that of the “old� democracies

80

90

70

80 70

60

60

50

50

40

40

30

30

20

20

10

10 2009

Canada

1999

UK

1996

India

1989

USA

1980

Indonesia

1971

South Africa

1962

Turkey

1951

Brazil

0

0

Source: Election Commission of India.

Note: the rate reported refers to the most recent elections organised in the country.

Source: International Institute for Democracy and Electoral Assistance (IDEA).

One sign that democracy is firmly embedded in India is the growing socio-political discontent, evidenced not only by a historically high turnout (over 66%) in the May 2014 national legislative elections, but also by the results, which translate a political turning point on three counts. Firstly, the victory of the BJP marked the alternation of political power in a system dominated by the Congress Party since independence. It is also the

first time that a single party has won an absolute majority of seats since 1984 and, thirdly, it differs from past electoral results in that a political figure from a federated state (Gujarat) was appointed as prime minister. At the same time, the number of seats won by regional parties is continuing to grow (cf. Figure 17).

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19

3/ The challenges for economic policy are many on the road ahead 3.1. Growth: ease supply-side constraints

and increase the job-creation potential of growth

3.1 .1

A less supportive international context

India’s 2000s decade of high growth came to an abrupt halt with the 2008 international financial crisis.

Although, at first, the Indian economy had seemed to successfully weather this external shock (cf. Figure 20) thanks to the effects of a highly accommodative fiscal and monetary policy (cf. Figure 21), a more persistent economic slowdown seems to have set in. The Indian growth regime thus appears to have changed since the 2008 financial crisis, as reflected in the IMF’s estimate of the country’s growth potential, revised downwards to between 5.5% and 6.5% (against the former 7.5%)

Figure

in the absence of new economic reforms. [ 14] This change can be explained first by the less supportive international environment in the wake of the crisis (the “new normal”): in some regions (European Union, China and, to a lesser extent, the United States) that are key economic partners for India (cf. Section 3), economic growth is likely to remain sluggish in the medium run compared to the pace before the 2008 crisis, according to IMF forecasts. Additionally, the normalisation of monetary policies now underway notably in the United States – marking the end of the crisis-related ultra-expansionary period (quantitative easing) – and more generally the heightened caution of international investors following the introduction of new regulations such as Basel III will most likely contribute to a tightening of India’s financing conditions (Figuet et al., 2013).

Figure

20

Marked easing of India’s “policy-mix” during the 2008 crisis

Contributions to quarterly GDP growth: a short-lived economic rebound (constant 2004–2005 prices, pp) ■ GFCF

21

■ Stimulus via monetary policy (- var. of key repo rate, pp) ■ F iscal stimulus (var. of structural primary deficit, % of potential

■ Private consumption ■ Other

GDP)

GDP 4

16 14

3

12

2

10 8

1

6 4

0

2

-1

0

-2

-2 -4

-3

-6

2007-08 2008-09 2009-10

2010-11

2011-12

2012-13

2013-14

Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 2005-06 06-07 07-08 08-09 09-10

Source: CSO.

10-11

11-12

12-13

13-14

Note: the structural primary deficit is estimated using the Hodrick-Prescott filter to smooth the influence of business cycle fluctuations. A positive monetary stimulus corresponds to a reduction of the key interest rates: a positive fiscal stimulus corresponds to an increase in the structural primary deficit.

Sources: RBI; Misra and Gosh (2014).

[14] T he Planning Commission and Bhandari (2013) estimate this potential at about 7% if no economic reforms are undertaken.

20

© AFD / Macroeconomics and Development / September 2014

22 Graphique Figure Energy deficit and economic growth (%)

■ Energy deficit (%) Economic growth (5-year average) 12 10

• Despite having considerable potential (India has the

8

world’s fourth largest proven reserves of coal), the country recorded an energy deficit [ 17] of nearly 9% in 2012-2013 according to the Ministry of Energy (cf. Figure 22). The situation in the electricity sector is particularly critical, with a deficit of up to 11% during peak-demand periods, and frequent power outages (lasting from several to ten hours a day depending on the state), the most dramatic power failure being th at in Ju ly 2 01 2 . I n ad d itio n , a round 400 million Indians still have no access to electricity,

6 4 2

2011-2012

2009-2010

2007-2008

1997-1998

0 2005-2006

The need to strengthen infrastructure seems particularly pressing in the energy, transport and storage sectors (cf. Box 5 for the last sector).

inadequate relative to the country’s growing needs: the rail network, which is certainly one of the most extensive in the world, does not benefit from the investment needed to modernise it (mainly due to passenger fares being cross-subsidised by freight revenues; cf. Box 8). The road network, also large in terms of kilometres, faces severe congestion problems (for example, national motorways account for 2% of the road network but 40% of road traffic), while a widespread system of internal customs duties also slows down freight transport.

Among the other difficulties highlighted by the French Economic Mission (2013a) are the inadequate port capacity and the limited network of oil and gas pipelines.

2003-2004

The inadequacy of infrastructure is a major barrier to economic activity in India, and one cited by Indian business leaders as the prime factor adversely weighing on the business environment ahead of corruption and bureaucracy (Global Competitiveness Index, 20132014). In terms of the infrastructure criterion, India ranks lowest among the BRICS [ 16] and holds 85th place out of the 148 countries considered).

• transport infrastructure also appears to be

2001-2002

3.1.2 Need for substantial investment in infrastructure

especially in rural areas. In this sector, price capping and the poor level of cost recovery hinder new power station construction projects and impair the quality of distribution (over half of production is seemingly “lost in transmission”; Chaponnière, 2014);

1999-2000

Yet, the significant slowdown of the Indian economy since the 2008 international financial crisis – and the most pronounced among the emerging economies – results primarily from domestic barriers of a structural nature, [ 15] and these have recently been accentuated by the climate of uncertainty surrounding the 20132014 electoral period (regional elections in five states in 2013; national legislative elections in April/May 2014).

The return of the Indian economy to a sustainably stronger rhythm of growth comes up against various supply-side constraints, which have been exacerbated by the country’s economic “take-off” (cf. Sections 3.1.2 and 3.1.3). And linked to this, the build-up of macroeconomic imbalances over the 2000s has since narrowed the public authorities’ margins of manoeuvre with respect to growth-enhancing policies (cf. Sections 3.2 and 3.3).

Source: Ministry of Energy

[ 15] According to the IMF (2014a), two-thirds of the recent slowdown is caused by internal factors and one-third by the global economic and financial situation. [ 16] Brazil, Russia, India, China, South Africa. [ 17] This is defined as the gap between demand and domestic energy production.

/ The challenges of India’s economic policy/

21

These shortfalls in infrastructure hamper the country’s growth and development through different channels: production is constrained, the price competitiveness of

Box

5

businesses worsens, the trade deficit widens (cf. section 3.3), inflationary pressures are heightened (cf. Box 5) and people’s mobility is hampered.

Inflationary pressures in India: the result of external exogenous factors and a reflection of the country’s infrastructure gap

Background and causes of inflation

- energy products (about 9.5 in the CPI), which are largely imported, have also contributed to the recent resurgence of inflationary pressures due to rising oil prices compounded by the rupee’s downward trend;

23

Inflation in India: WPI versus CPI (%) WPI (reference)

CPI (AL)*

25 20 15 10 5

RBI’s target range

0

2010-2011

2006-2007

2002-2003

1998-1999

1994-1995

-5 1990-1991

- as the main contributor to inflationary pressures (cf.

Figure 24), food inflation (which accounts for nearly a 24% share of the wholesale price index [WPI] and nearly 48% in the consumer price index [CPI]) has risen due to the effects of “exogenous” factors, including notably the monsoon (periods of drought in 2009-2010), guaranteed minimum support price policies and social policies (demand-side effect linked to the implementation of NREGA). Supply-side factors, such as the country’s infrastructure gap regarding transport and storage, also explain recent pressures on food prices; [ 18]

Figure

1986-1987

The accelerating pace of inflation in recent years is driven by several factors (Mission économique, 2013b; RBI, 2014a):

- finally, non-volatile inflation (or core inflation, which excludes food and energy) has suffered from steep wage increases relating to the anticipated rise in inflation (wage-price spiral) and the reduction of subsidies, mainly fuel subsidies. Inflation was also driven by the credit dynamic observed in recent years.

1982-1983

Historically, India has experienced periods of high inflation: until the mid-1990s, inflation averaged 8-9% (measured on wholesale prices, which is the current reference index for the RBI) and reached peaks of nearly 15% (as a result of the foreign exchange crisis in the early 1990s). Between the mid-1990s and the mid2000s, inflationary pressures were much more moderate (average inflation around 5%, which was in the range targeted by the RBI) on account of the change in the monetary policy framework. However, sporadically from 2007 and more regularly since 2010, inflation has again reached elevated levels (averaging nearly 9% since this date). When measured using the consumer price index (which has been aggregated only since 2011), inflation has regularly exceeded 10% in recent years (given the higher share of food in calculating this index; cf. Figure 23).

* Agricultural labourers Note: the WPI is the RBI’s current primary index, calculated on all commodities. The CPI (AL) is calculated on the basis of data from agricultural labourers’ households. A combined index for all households has only existed since 2011. The breaks in the series correspond to the different changes made to the baseline year.

Sources: CSO, RBI.

[18] A ccording to the Mission économique (2013b), around 25% of national wheat production and 40% of fruit and vegetable production are lost each year due to the lack of storage capacity. The poor condition of the roads also affects inflation: the difficulties of transporting agricultural produce from surplus areas to deficit areas implies, for example, that the average price of rice can triple depending on the geographical zones.

22

© AFD / Macroeconomics and Development / September 2014

Figure

Inflation and the evolution of the monetary policy framework

24

Contributions to recent inflationary pressures: the key role of food and energy products (pp) ■ 2000-2007

In January 2014, an expert committee appointed by the RBI published a report calling for reform of the country’s monetary policy framework. The main proposals are as follows:

■ 2008-2012

- a nchor monetary policy to an objective of inflation, which would thus become the main goal of monetary policy, with secondary targets of economic growth and financial stability;

8 7 6

- t ake the CPI as the reference inflation indicator, as this is a more effective measure of the household cost of living;

5 4

- s et an inflation target of 4% +/- 2% with a two-year horizon. In the short run, the committee recommends reducing inflation from 10% to 8% over one year and then to 6% within two years;

3 2 1

- e liminate the administered setting of prices (as well as interest rates and wages);

Manufactured products (excl. food)

Non-food products

Energy products

Food products

WPI

0

- r eview the composition of the Monetary Policy Committee so as to include external experts; - s implify the key policy rate and modernise the tools used; - r ecommendations on short-term management of volatile capital flows and excessive exchange rate fluctuations.

Source: RBI.

To tackle these difficulties, India’s public authorities have set ambitious catch-up objectives under the Twelfth Five-Year Plan (2012-2017), which provides for infrastructure investments worth USD1,000 billion over the period (equivalent to 10% of GDP per year; cf. Table 7). Nonetheless, given the country’s budget constraints, this objective may prove difficult to reach, [ 19] even if the public authorities are counting on greater involvement of the private sector (48% of financing compared to 37% under the Eleventh Plan).

Moreover, improving the infrastructure sectors also hinges on important structural reforms in terms of pricing and regulation, which raises the question of the country’s governance issues (see above). The sharp

slowdown in investment in India over recent years is due not only to the deteriorating macro-financial conditions, but also to the growing delays in approving and implementing major infrastructure investment projects (cf. Figure 25). This blocked situation was caused not only by the increasing difficulty in acquiring land and obtaining environmental permits, but also by the impact of the serious corruption scandals (Anand [ 20] and Tulin, 2014).

Another example of major structural reform that needs to be pursued to ensure the country’s investment financing is the banking and financial system, which is still largely dominated by weakened and inadequately sized public-sector banks (cf. Box 6).

[ 19] On this count, it should be noted that the Eleventh Five-Year Plan, which planned for “only” USD411 billion of infrastructure, was not totally achieved. [ 20] To tackle these difficulties, the Government set up the Cabinet Committee on Investment (CCI) in January 2013, which is responsible for fast-tracking approvals for stalled investment projects. The first effects of this decision are quite encouraging as in October 2013, the CCI had cleared 92 large investment projects (out of a total 330 investment projects submitted to the Cabinet), amounting to almost 4% of GDP.

/ The challenges of India’s economic policy/

23

Table

7 Solving India’s infrastructure problem: a financial challenge…

6 India’s banking and financial system: a sector that is still highly regulated, dominated by public-sector banks and inadequately sized with regard to the country’s development challenges

Box

(infrastructure investment under the Twelfth 2012-2017 Plan) Sectors

USD billions

Share (%)

Electricity

364 33

A sector dominated by public-sector banks…

Roads and bridges

183 16

Telecommunications

189 17

Railways

129 12

Irrigation

101 9

Although relatively diversified, the Indian financial system is largely dominated by scheduled commercial banks, which alone accounted for 58% of India’s financial assets in 2010 (cf. Figure 26). The share of public-sector banks in this commercial activity is still very high: public-sector commercial banks represented some three-quarters of bank assets and nearly 80% of bank deposits in 2011/2012 (cf. Table 8). [ 21] Moreover, the State Bank of India (SBI) group carries particular weight in the Indian banking system: it alone represents over 20% of bank assets and deposits. The penetration of foreign banks remains limited (around 7% of the country’s bank assets and 4% of bank deposits).

Water supply & sanitation 51 5 Ports

40 4

Storage

30 3

Airports

18 2

Oil and gas pipelines

12 1

Total

1 115

100

Figure

26

Source: Planning Commission (2013).

A financial sector dominated by commercial banks (2010) Figure

25

■ % financial assets

… but also a regulatory challenge

90

(proportion of stalled investment projects in the energy and transport sectors since 2007, % of each category’s total) Energy

■ % GDP

80 70 60

Transport

50

80

40

70

Regional rural banks

20

Pension funds

30

Mutual funds

0 Cooperative credit institutions

40

Non-banking financial institutions

10 Commercial banks

20

50

Insurance companies

30

60

10 0 1995

1997

1999

2001

2003

2005

2007

2009

2011

2013

Note: the commercial bank sector includes public-sector banks, domestic private-sector banks and foreign banks.

Source: IMF (2013).

Source: RBI.

[21] Moreover, around 69% of insurance premiums and 80% of insurance assets are provided by public insurers, according to the IMF (2013).

24

© AFD / Macroeconomics and Development / September 2014

Table

8

The preponderance of public-sector banks (2011-2012) Commercial banks

Public-sector banks

Including SBI and Associates

Domestic private banks

Foreign banks

Total assets % bank assets % GDP

100 73 21 20 7 94 68 20 19 7

Loans and advances % bank credit % GDP

100 77 23 19 4 57 44 13 11 2

Deposits % total deposits

100 78 22 18 4

% GDP

73 56 16 13 3

Number of banks

89 26 6

20 43

Source: RBI.

… and highly regulated, despite recent changes Cottet (2011) points out that, despite the reforms introduced in the 1990s, India’s financial sector is still highly regulated: - The setting-up of private banks is strictly controlled (between 2004 and 2013, no new banking licences had been issued to new private banks since the granting of ten licences in 1993-1994 and two licences in 2003–2004).

- The financial actors are considerably constrained by a s s e t i nve s t m e nt re q u i re m e nt s : t h e y a re ob lig e d to hold a substantial share of their assets as government securities (a minimum of 24% for banks, 50% for insurance companies and 100% for state pension funds); regulation of interest rates for public-sector banks (a requirement that 80% of loans be granted at a rate set by the RBI); a substantial share of the loans must be granted to sectors considered as priority (agriculture, small enterprises, retail trade, microcredit, education, real estate).

- There is also a high level of protectionism with limitations on the purchase of banking products and services from foreign financial institutions, as

well as on the opening of branches of foreign banks.

However, the arrival of a new governor at the Reserve Bank of India in September 2013 has given rise to some degree of change in the country’s financial policy. Among the measures already adopted is an initial easing of the licensing policy for new banks (two new licences have just been granted and the RBI is now displaying an intention to grant licenses “more re g u l a rl y ” ) , a s we l l a s m e a s u re s to d e e p e n t h e gove r n m e nt b o n d m a rket a n d c re ate fo r wa rd instruments so that investors can more effectively hedge against the risks of fluctuating interest rates and exchange rates (Mission économique, 2014). New measures have also been recommended by an expert p a n e l co nve n e d by t h e R B I ( 2 0 1 4 a ) , i n c l u d i n g a reduction in the State’s shareholding in public-sector banks (to less than 50%), in favour of private investors, as well as measures to strengthen (public-sector) bank regulation.

The need to continue developing and opening the banking and financial sector Although India’s financial sector underwent substantial development in the 2000s following major reform in

/ The challenges of India’s economic policy/

25

t h e 1 9 9 0 s , i t s s i z e st i l l a p p e a rs m o d e rate by international comparison. For example, in 2012, the level of outstanding credit granted by the financial sector as a whole represented 76% of India’s GDP, against 124% for the BRICS (excluding India), according to the World Bank (cf. Figure 27). Another illustration: a l t h o u g h d o m e st i c co r p o rate b o n d m a rket h a s certainly been growing rapidly since 2007, it remains shallow when compared internationally, [ 22] a situation l i n ke d p a r t i c u l a rl y w i t h t h e c row d i n g - o u t e ffe c t created by the Government’s hefty financing needs (Raghavan et al., 2014). According to the RBI, this market represented only 1.6% of GDP in 2010, against nearly 9% of GDP in China and 27% of GDP in Malaysia, for example. The Planning Commission (2011) emphasises the need to develop household financial savings through reform of the insurance markets and retirement pensions, as well as by promoting the financial inclusion of households. The financial sustainability of India’s development strategy will doubtless depend on the easing of the legal constraints imposed on financial institutions regarding the allocation of their assets (mentioned notably by the RBI), as well as a more open financial account particularly with respect to FDI, in a context where concessional donor funding is dwindling (cf. section 3.3).

3.1.3 Fostering human capital to increase the potential and job-content of growth India also faces a shortage of human capital, mainly as a result of the belated recognition of the need for compulsory primary education (law adopted in 2009).

Despite a steep increase in the primary school enrolment rate (over 90%), the illiteracy rate is still high by international comparison (around one-third) due to the recency of this law, the high school drop-out rate and an insufficient quality of education. Also, vocational training is underdeveloped in India, given the prevalence of informal employment. It is thus hardly surprising that, historically, human capital has only made a limited contribution to the country’s

Figure

Strong credit growth, but still limited in size compared to other major emerging economies (outstanding credit provided by the financial sector/GDP) India

BRICS (excl. India)

LMICs

140 120 100 80 60 40 20 0 1980

1984

1988

1992

1996

2000

2004

2008

2012

Source: World Bank (WDI).

economic growth (Ministry of Finance, 2013). What is more, the low level of qualification of the vast majority of the workforce impedes the reallocation of labour to the industrial sector and certain services (see above), and calls India’s economic model into question. The public authorities have thus set the goal (cf. Twelfth Five-Year Plan) of stepping up the share of manufacturing in the economy from its current 15% to 25% by 2017 (cf. Box 7). In a context of demographic pressures and despite sustained economic growth (see above), the relatively weak level of job creation in India, particularly formal employment, is partly attributable to this underindustrialisation, the services sector providing either highly qualified jobs reserved for an elite or highly precarious informal employment.

[22] Corporate foreign currency bond issues have been considerable in recent years.

26

27

© AFD / Macroeconomics and Development / September 2014

Box

7

An example of supply-side constraints in India: the industrial sector

India’s low rate of industrialisation: the role of supplyside constraints Several factors go to explain the country’s low rate of industrialisation: first of all, there is the earliermentioned lack of infrastructure. For instance, power blackouts dampen companies’ production and/or impair their price competitiveness (for those who can afford to equip themselves with private relay systems).

T h i s s i t u at i o n co nt ra st s w i t h co u nt r i e s s u ch a s Thailand, China or South Korea, which supply their industries with cheap power (Mission économique, 2013a). Another example is freight transport, where the problem of congestion is compounded by cost problems: in China freight tariffs are only 58% of those in India at PPP. The lack of training for the workforce – which is abundant in India and should thus create a comparative advantage – is a further setback often cited to explain the low share of industry (Ministry of Finance, 2013). Another significant barrier linked to the labour market is the impact of regulations that d i s adva nt ag e b u s i n e s s e s d u e to t h e e ffe c t i ve co n st rai nt s t h e y i mp o se and th ei r co mp l ex i ty. T he re are forty-five different labour laws at national and state level. As a result, manufacturing employment tends to be distributed around two poles, either in very small and most informal enterprises (fewer than 10 workers), or in very large labour-and/or-capitalintensive firms (over 500 workers according to Chaponnière, 2014). Complementary to this, the hypothesis of the “missing middle” [ 23] is of note, as is the effect of the 1947 Act that requires enterprises employing more than 100 workers to obtain state authorisation to dismiss personnel. More generally, other factors often foregrounded are the business climate and political uncertainty.

India’s sectoral transformation from agriculture to services thus seems to result not simply from a strategic choice (to become the “world’s office”, as Boillot, 2009, mentions), but also from a constrained choice in view of all the barriers facing industry.

it h a s m a n a g e d to e s t a b l i s h a f i r m p o s i t i o n i n s o m e sectors, such as precious stones and gold process i n g , petrochemicals, oil refining , metallurgy (the world’s fourth producer), various transport equipment (twowheelers), as well as aerospace, biotechnologies and generic drugs (global market leader). On the other hand, with the move towards decentralising economic policy since the 1990s, some states have been able to expand their industrial sector. This is particularly the case of Gujarat (where manufacturing accounts for 25% of GDP and industry for nearly 30%) and Maharashtra, which concentrates almost 21% of India’s manufacturing output (cf. Maps 2 and 3). Moreover, Chaponnière (2014) notes that the states with the most dynamic growth in (sophisticated) services are also the most industrialised.

Map

2

States’ varying levels of industrialisation Share of manuf. (% of GDP)

Jammu and kashmir Himachal Pradesh

Punjab

Share of manuf. (% of GDP) ■ <5 ■ 5-10 ■ 10-15 ■ 15-20 ■ > 20

Uttaranchal Haryana Rajastan

Delhi

Sikkim Arunachal Pradesh Uttar Pradesh

Assam Bihar

Madhya Pradesh Chhattisgarth

Gujarat

Nagaland

Meghalaya Tripura Jharkhand West Bengal

Manipur Mizoram

Orissa Maharashtra Andhra Pradesh Andaman and Nicobar

Kamataka

Kerala

Tamil Nadu

High-growth sectors and experiences in India’s most industrialised states The boilerplate image of India’s lagging industry is nonetheless somewhat deceptive… On the one hand,

Sources: CSO, RBI, authors’ calculations.

[ 23] Hasan and Jandoc (2010) have shown that labour regulations, which differ across Indian states, can impact the prevalence of large-scale, labourintensive enterprises in India.

/ The challenges of India’s economic policy/

27

3.2. Public finance: expanding fiscal space Map

3

3.2.1 Public finances particularly vulnerable to a downturn in economic conditions

High concentration of industrial production (share of each state’s

manufacturing in national total 2011-2012, constant prices) Share of manuf. (% of national total) ■ ■ ■ ■ ■

Jammu and kashmir Himachal Pradesh

Punjab

< 4.2 4.2-8.3 8.3-12.5 12.5-16.7 > 16.7

Uttaranchal Haryana Rajastan

Delhi

Sikkim Arunachal Pradesh Uttar Pradesh

Assam Bihar

Madhya Pradesh Chhattisgarth

Gujarat

Nagaland

Meghalaya Tripura Jharkhand West Bengal

Manipur Mizoram

Orissa Maharashtra Andhra Pradesh Andaman and Nicobar

Kamataka

Kerala

Puducherry Tamil Nadu

Sources: CSO, RBI, authors’ calculations.

With a level of public debt nearing 70% of GDP in 2012/2013 and a fiscal deficit of over 7% of GDP (according to the MoF [ 24] ), India’s public finance situation appears at first glance to be relatively poor given the country’s level of economic development. It is also in contrast with that of the other major emerging economies (over the 2010-2013 period, the public debt of the BRICS excluding India averaged less than 40% of their GDP, and their fiscal deficit was around 2.5% of GDP). It should be noted, however, that the years 2003-2012 marked a break with the two previous decades with respect to how the ratios of India’s public debt and fiscal balances evolved. In fact, total debt decreased by 17 percentage points of GDP over the period, compared with an increase of 19 and 11 percentage points of GDP respectively in the 1980s and 1990s (cf. Figure 28). The overall fiscal deficit reached a historic low of 4% of GDP in 2007/2008, while the “revenue deficit” (balance of current revenue and current expenditure) was close to balance at the same date. These developments – more favourable than in the past – are partly due to the states’ improved fiscal balances over this period, which coincided with the implementation of fiscal rules (cf. Box 8). They also owe much to the positive effects of the high economic growth during the 2000s. [ 25] Questions thus arise as to whether the improvements in India’s public finances seen over the 2000s are sustainable. The recent economic slowdown shows that they are highly sensitive to economic growth: the IMF’s latest debt sustainability analysis (IMF, 2014a) confirms that rapid real GDP growth was a major contributing factor to the recent phase of a decreasing public debt-to-GDP ratio, and the return of a less supportive dynamic following the economic downturn of the past two years (cf.

Figure 29).

[24] D ifferences may exist between the public debt figures released by the MoF and those of the RBI (which manages central government debt).

Thus, in 2010/2011 (final figures), total public debt (centre and states combined) stood at 72.1% of GDP according to the MoF, as opposed to 66% of GDP according to the RBI. Likewise, the figures for external debt released by the RBI and the MoF differ: for example, in 2012/2013, the external public debt-to-GDP ratio was 3.0% according to the RBI against 1.8% according to the Indian Public Finances (MoF), or 4.4% according to the Indian’s External Debt (MoF).

[25] F irst, due to the denominator effect, as the level of public debt continued to rise over the period from around USD500 billion in 2003/2004 to USD1,240 billion in 2012/2013.

28

© AFD / Macroeconomics and Development / September 2014

Figure

Figure

28

High public debt-to-GDP ratio, which nonetheless decreased over the 2000s

Key role of growth in public debt dynamics (contributions to the change in the total debt-to-GDP ratio, % of GDP)

(centre + states combined debt, % of GDP) ■ Changes in Debt-to-GDP ratio (RH scale) Total public debt 90

■ Primary deficit ■ Real interest rate Change in public debt

6

80

4

70 60 50 40 30

4,0

0

2,0

-4

10

■ Real GDP growth ■ Other

6,0

2

-2

20

0,0 -2,0 -4,0

2011-12

2005-06 2007-08 2009-10

1991-92 1993-94 1995-96 1997-98 1999-00 2001-02 2003-04

1987-88 1989-90

-6 1981-82 1983-84 1985-86

0

Box

-6,0 2002-2003 / 2010-2011 (per year)

Source: RBI.

29

2011-2112

2012-2113

Source: FMI (2014a).

8

History of fiscal adjustment since the 1990/91 crisis and the introduction of rule-based fiscal control

History of fiscal adjustment since the 1990/91 crisis Since the 1990s, four main phases of fiscal adjustment can be identified in India (cf. Figure 30): - From 1990/1991 to 1996/1997, India underwent a phase of fiscal adjustment, triggered by its balance of payments crisis. A key measure adopted during this period was the 1994 agreement between the RBI and the MoF, which put an end to the almost automatic monetisation of government debt.

- From 1997/1998 to 2001/2002, India’s public finances again deteriorated, partly as a result of t h e p u b l i c s e c to r wa g e h i ke s ( F i ft h Pay Com mi ss i o n), and th e rec ap i tal i sati on gove rnment-owned electricity utilities (Buiter and Patel, 2010).

- From 2002/2003 to 2007/2008, the fiscal deficit declined more sharply than during the years following the 1990/1991 crisis. However, Chakraborty and Dash (2013) point out that this recovery did not stem from a fiscal adjustment, but rather historically high levels of economic growth (“fiscal co r re c t i o n w i t h o u t f i s c a l co nt rac t i o n ” ) . T h i s involved both central government and the state governments, which had contributed little to the 1990/1996 fiscal adjustment. It also coincided with the introduction of fiscal rules (see below).

- Since 2008/2009, India has again experienced a deterioration of its public accounts, which has forced the country to engage in a new programme to reduce the fiscal deficit over the past two years in line with the recommendations of the Thirteenth Finance Commission (Cottet, 2011).

Figure

30

The four phases of fiscal adjustment in India since the 1990s (average annual change in fiscal deficit, pp) ■ Centre

■ States

Average real growth (RH scale)

0.6

9.0

0.4

8.0 7.0

0.2

6.0

0.0

5.0

-0.2

4.0 3.0

-0.4

2.0

-0.6

1.0

-0.8

0.0 1990-1996

1997-2001

2002-2007

2008-2012

Sources: MoF, CSO.

/ The challenges of India’s economic policy/

29

Figure

Fiscal rules at central and state government levels The introduction of fiscal rules in India is relatively recent. They first came into force at central government l e ve l t h ro u g h t h e 2 0 0 4 F i s c a l a n d Re s p o n s i b i l i t y Budget Management Act (FRBMA) and are based on two core rules and related provisions: - A fiscal deficit target of 3% of GDP; note that this is an ambitious target given that it has only been achieved once since the 1980s (in 2007/2008). In light of the crisis, the Government anticipates that this target will not be reached until 2016/2017 (cf.

Figure 32).

- A “golden rule” whereby the “revenue deficit” ( b a l a n ce of c u r re nt re ve n u e a n d c u r re nt expenditure) must be in balance (in other words, n e w b o r row i n g i s o n l y u s e d to f i n a n ce i nve st m e nt s ) . This equilibrium, which was only neared in 1981/1982, is not likely to be reached in the medium term, and the Government projects a level of 1.5% of GDP in 2016/2017.

- Introduction statements.

of

medium-term

fiscal

31

Public finances of state governments have weathered the crisis relatively well (% of GDP) “Revenue deficit”

Fiscal deficit 7 6 5 4 3 2 1 0 -1 -2 1980-81

1985-86

1990-91

1995-96

2000-01

2005-06

2010-11

policy Source: RBI.

- T h e R B I i s n ot a u t h o r i s e d to s u b s c r i b e to gove r n m e nt s e c u r i t i e s a s f ro m M a rch 2 0 0 6 , barring exceptional circumstances.

At state government level, fiscal rules were adopted by most states in 2005-2006 through the Fiscal Responsibility Laws (FRLs). This measure was encouraged by the Government following slippages in state-level public finances in the late 1990s and early 2000s despite the stringent constitutional constraints on their borrowing (see below). To promote adoption of these fiscal rules and ease the states’ debt burden, t h e ce nt re i nt ro d u ce d d e bt re l i e f m e a s u re s a n d reduced interest rates. The rules adopted are most often similar to those in force at the centre. On the whole, state governments have achieved the fiscal target more effectively than central government: since the adoption of the FRLs, the overall state fiscal deficit has remained below the targeted 3% of GDP, despite the recent economic slowdown, while the “revenue deficit” has been close to balance.

Figure

32

At central level, persistent deviations from the fiscal targets set by the FRBMA (central government fiscal deficit and “revenue deficit”, % of GDP) “Revenue deficit”

Fiscal deficit 7 6 5 4 3 2 1

Sources: RBI, MoF (2014/2015 budget).

30

© AFD / Macroeconomics and Development / September 2014

2016-17

2015-16

2014-15

2012-13

2013-14

2011-12

2010-11

2009-10

2007-08

2008-09

2006-07

2005-06

2004-05

0

India’s public finances also seem vulnerable to contingent liability shocks (FMI, 2014a) emanating both from public banking sector since the recent economic downturn (cf. Box 9) and from the stateowned electricity companies, as well as from the development of public-private partnerships (ADB,

Box

9

2012). [ 26] Lastly, the IMF (2014b) highlights the future pressures on public finances due to health expenditure (cf. roll-out of the universal health care system): in present value, this expenditure could increase by over 13 percentage points of GDP by 2050.

A sharp deterioration in banking asset quality, creating the need for recapitalisation by the Government

The economic slowdown over the last years, the longer delays in starting up major investment projects, the increasing cost of capital and what the RBI (2013) judges to be an excessive rise in the leverage of major corporates (particularly since the 2008 global financial crisis) have all contributed to the recent deterioration of the quality of banking assets in India. The level of bad loans has been on the rise since 2010/2011 and is p ote nt i a l l y h i g h e r t h a n off i c i a l st at i st i c s wo u l d suggest. The rate of non-performing loans (NPLs) reached 3.6% mid-2013 compared to a record low of 2.3% in 2007/2008. Moreover, if so-called restructured loans [ 27] are added, over 10% of banking assets were “stressed” in September 2013 (cf. Figure 33). Although historically only about 15% of these restructured loans become NPLs, there is concern that this ratio may turn out to be higher for the advances classified as restructured loans since 2008 (RBI, 2013). These stressed loans are concentrated in a few sectors where public sector banks are heavily exposed: five sectors account for over 50% of these loans (whereas they represent only a little over 20% of the credit granted), of which about one-third is for the infrastructure sector alone (cf. Figure 34). Given their particularly high exposure in these sectors (55% of their loan portfolios), public sector banks have seen a marked worsening of their NPL rate (mid-2013, this stood at 4.1% as opposed to 1.9% for private banks). The proportion of stressed loans is also higher in publicsector banks (over 12% compared to 6% at most for the other types of banks). Given this elevated level of stressed loans, the provisioning ratio proves to be inadequate (about 47% for the NPLs alone, according to the IMF). Additionally, although the SBI group has stepped up its provisioning efforts since 2011 (to a rat i o of a b o u t 6 0 % m i d - 2 0 1 3 ) , t h e s o - c a l l e d nationalised banks have seen their provisioning ratio fall (to less than 40% mid-2013). For this reason, the RBI tightened its provisioning requirement at the end of 2013.

Figure

33

Over 10% of bank loans are “stressed” ■ Restructured loans (% of total loans) ■ Non-performing loans (% of total loans) 12 10 8 6 4 2 0 2008

2009

2010

2011

2012

2013

Source: RBI.

Figure

34

Stressed loans are concentrated in the infrastructure sectors (%, September 2013) ■ Share of total credits ■ Share of stressed credits 60 50 40 30 20 10 0 Infrast.

Metallurgy

Textiles Aeronautics

Mining

Total

Source: RBI.

[ 26] In 2010, this study counted 1,017 “public-private” partnerships in the infrastructure sectors, representing over 6% of India’s GDP. [ 27] Restructured loans are loans contracted by counterparties that have liquidity problems but a low risk of solvency problems. This type of loan has increased significantly since 2008 as the conditions for classifying loans under this category were eased due to the global financial crisis. These looser conditions are due to be abolished as from April 2015.

/ The challenges of India’s economic policy/

31

This situation has already led the public authorities to undertake several recapitalisations since 2007/2008 (totalling around 0.7% of GDP according to RBI figures; cf. Table 9). Furthermore, the stress tests run by the RBI and IMF conclude that in the most severe scenario the extent of the additional government recapitalisation required could reach 5% of GDP (and even further recapitalisation representing up to almost 2% of GDP to comply with the Basel III framework). In total, even if these figures point to a manageable financial effort for the Government (particularly in view of the

Table

9

experience of some European countries following the 2 0 0 8 f i n a n c i a l c r i s i s ) , i t co u l d n o n et h e l e s s b e considerable for India’s public debt trajectory. Yet according to the IMF (2014a) and by international comparison, the moderate size of India’s banking sector compared to the country’s real economy (see above) as well as its relatively satisfactory level of capitalisation (according to the IMF’s financial soundness indicators [FSIs]) would indicate limited systemic risk overall.

Estimate of recapitalisation needs due to the deterioration of banking assets and Basel III implementation (% of GDP) Financing by banking sector

Financing by Government

Total

Recapitalisations since 2007/08

nd 0.7 0.7

Recapitalisations required due to rise in NPLs (most severe scenario)

2.9 5 7.9

Recapitalisations required for Basel III compliance (fast-track scenario)

3.4 1.9 5.3

Total

6.3 7.6 13.9

Sources: IMF (2014a), RBI.

However, despite these fiscal imbalances, the prospect of a sovereign debt crisis in India seems relatively limited, as was the case in some of the eurozone countries in 2010/2011.

- Firstly, since the 1990/1991 crisis, most of India’s public debt is domestic and rupee-denominated (cf.

Figure 35). In addition, all of the country’s overseas foreign currency borrowing has been from international donors, as India made the choice not to issue debt securities on international financial markets. This debt also has relatively long maturities (almost two-thirds of public debt in 2012/2013 had tenors of more than five years, and the remaining averaged nearly ten years). While the fiscal deficitto-GDP ratio is considerably higher in India than in the other major emerging economies (a ratio of 1 to 3), public financing needs (including debt amortisation) are quite similar (in the region of 1 to 1.3), given the relatively long maturity (as well as the largely regulated domestic interest rates). Finally, market borrowing remains limited (less than 15% of the total in 2012/2013) on account of the regulatory obligation for financial institutions to hold a

32

substantial share of their assets in debt securities issued by the Indian Government.

Figure

35

The share of public debt exposed to market and liquidity risks is limited (% of total) External debt Market borrowing

ST debt (< 5 years)

50 45 40 35 30 25 20 15 10 5 0 1980-81

Source: RBI.

© AFD / Macroeconomics and Development / September 2014

1985-86

1990-91

1995-96

2000-01

2005-06

2010-11

- Next, although India is structured on a federal basis (a factor often viewed as heightening sovereign risk, cf. Box 11), the fiscal rules in force since 2005/2006 (see above) and the relatively stringent norms on the level of indebtedness of the states (and also the “third-tier” local authorities) in principle mitigate the risk of fiscal slippage typical of multi-tier systems of governance. Moreover, several studies (recently Allard et al., 2013) highlight that the inter-state insurance operating in a federal system can actually have a beneficial function (for growth and ultimately public finances). Saiegh (2009) shows that countries governed by coalition governments appear to be less likely than others to default on their debts, mainly because creditor interests are better taken into account.

Table

A relatively favourable track record of sovereign default compared to other major emerging economies (1800-2010)

10

Country

- Finally, India has a relatively favourable track record of repaying its external sovereign debt compared to some other emerging countries (cf. Table 10), which is a sign of a relatively high “debt tolerance” (Reinhart et al., 2003). Reinhart and Tashiro (2013) identify “only” three episodes of external sovereign default since India’s independence (1958, 1969 and 1972-1976), the 1990 crisis being seen as a “quasidefault” situation. Comparatively, Brazil and Turkey have recorded nine and eight episodes respectively of external sovereign defaults since the 19th Century (the most recent one for Turkey being in 2000/2001).

Number of external sovereign defaults

Date of the most recent of external sovereign default

Number of domestic sovereign defaults internes

Brazil 9

1983-1990

2

Turkey 8

2000-2001

0

Russia 5

1998-2000

4

India 3

1972-1976

0

South Africa 3

1993

0

Indonesia 3

2002

0

1939-1949

2

China 2 Source: Reinhart (2010).

Box

10

What risk is linked to fiscal federalism in India?

The economic literature never fails to point up the risks of fiscal slippage connected to fiscal federalism (recently Eichler and Hofmann, 2013). In fact, if no fiscal discipline framework exists, theory (corroborated by many empirical studies) predicts that federal governments will tend to undertax and/or overspend (moral hazard) insofar as they anticipate that the federal government will bail them out in case of overindebtedness.

Up to 2005/2006, the risk of the Indian states’ fiscal slippage, akin to that observed in the late 1990s and early 2000s, was a real possibility: - There is no explicit rule for cases of no bailout in India; moreover, the central government grants loans to state governments, which in the late 1990s represented 50% of their debt. These loans, added to the sizeable centre-state transfers (some of which are on an ad hoc basis), reinforce the expectation that central government will intervene financially in case of problems;

/ The challenges of India’s economic policy/

33

- Moreover, the borrowing regime for states, even t h o u g h re l at i ve l y co n st ra i n i n g o n p a p e r (discretionary approval from central government required for domestic borrowing , direct external borrowing prohibited by the Constitution [ 28] ), co u l d i n f ac t b e s e e n a s re l at i ve l y f l e x i b l e co m p a re d to m a ny ot h e r co u nt r i e s ( P u r f i e l d , 2004). Certainly, domestic borrowing was not at the time framed by quantitative ceilings, be it for deficits, debt burdens or the level of borrowing.

As a result, the centre’s theoretical discretionary control over the states’ public finances seems in practice to be weakened by the interplay of the country’s political balances (Cottet, 2011). owever, since 2005/2006, various measures have H been introduced to place state public finances on a sounder footing , including different mechanisms for restructuring debt and lowering the interest paid (Debt Swap Scheme - DSS; Debt Consolidation and Relief Facility - DCRF; National Small Saving Fund NSSF). Although these measures could be seen as likely to amplify moral-hazard behaviour of states, they have been accompanied by fiscal rules concerning deficits (see above), which on the contrary help to reduce the likelihood of any fiscal slippages by the states. Moreover, central government no longer lends to states other than within the framework of projects funded by international donors. In fact, except for some of the more heavily indebted states (Kerala, Punjab, Uttar Pradesh and West Bengal), the states’ level of indebtedness has greatly declined since the mid-1990s: in 2012/2013, the state debt-to-GDP ratio

3.2.2 A need to expand the fiscal space to support India’s pace of growth in the medium-to-long term In a context of substantial public debt, India’s fiscal policy remained mostly procyclical during the 2000s (Frankel et al., 2011), contrary to many other emerging and developing countries that managed to implement countercyclical policies (about one-third; cf. Figure 37).

The decade of booming growth did not therefore lead to a reduction but rather an increase in the level of cyclical government expenditure. Frankel et al. (ibid.) partly explain this procyclicality by the lower quality of

was below 25% (cf. Figure 36), which is the maximum threshold recommended by the Thirteenth Finance Commission.

Figure

36

A marked reduction in the states’ debt since 2005/2006: the sign of a bettercontrolled fiscal federalism (% of GDP)

■ Borrowing from Central Government ■ Dette Internal debt (excl. from central government and NSSF) ■ Other (funds, etc.)

40 35 30 25 20 15 10 Creation of the NSSF

5 0 1980-81

1985-86

1990-91

1995-96

2000-01

2005-06

2010-11

Source: RBI.

“institutions”. [ 29] The economic literature also (historically) foregrounds a degree of credit rationing as an explanatory factor for the procyclicality of fiscal policy in developing countries in the event of an economic downturn. In the case of India, whose institutional quality does not appear to be significantly lower than that of the other major emerging economies, it is the constraint of public debt sustainability, compounded by the fact that financing is mainly sourced from a small-sized (and certainly captive) domestic financial sector, that makes fiscal adjustments necessary during a slowdown of economic activity.

[ 28 ] S imilarly, the “third-tier” local authorities are not allowed to contract external debt directly and their domestic borrowing is subject to the approval of the relevant state.

[29] O ut of the sample of countries studied, institutional quality is considerably lower in countries pursuing a procyclical fiscal policy than that measured in countries whose fiscal policy is the most countercyclical.

34

© AFD / Macroeconomics and Development / September 2014

The large fraction of domestic savings absorbed by public financing needs also seems to crowd out borrowing by the private sector, which is then forced to rely on external capital to finance its activity (cf.

Section 3.3). This situation can also be illustrated by the limited size of India’s corporate bond market compared to the government securities market (cf.

Box 7).

Figure

37

India’s fiscal policy is much more procyclical than that of most other major emerging economies (coefficient of correlation between the cyclical components of public expenditure and economic growth and institutional quality) ■ Procycl. (1960-1999) ■ Procycl. (1999-2009) Institutional quality (RH scale) 1.0

0.7

0.8

0.6

0.6

0.5

0.4 0.2

0.4

0.0

0.3

-0.2

0.2

-0.4 -0.6

0.1

-0.8

0.0 Brazil

India

China South Africa Turkey

Indonesia

Note: a positive (respectively negative) correlation coefficient means that public expenditure is procyclical (resp. countercyclical). The quality of institutions is measured by an index whose value ranges from 0 (lowest quality) to 1 (highest quality). Four components are taken into account for this indicator: investment profile, corruption, law and order and bureaucracy quality.

If fiscal policy is to support the country’s economic development more effectively, India is thus confronted with the challenge of expanding its fiscal space by increasing government revenue and/or reducing nonpriority government expenditure.

• Considerable room for manoeuvre in terms of compulsory levies Fiscal pressure, measured by Central Government’s fiscal receipts to GDP, is quite moderate in India when compared internationally (cf. Figure 38). Even though such comparisons should be interpreted cautiously depending on whether the countries involved have federal structure or not, several elements suggest that the rate of compulsory levies in India could be raised.

Fiscal pressure increased sharply between 1950 and the late 1980s (by nearly 10 percentage points of GDP) but has since been virtually stagnant (cf. Figure 39) even though economic growth has increased markedly. This stagnation can be explained by the decreasing burden of indirect taxation, particularly customs duties, [ 30] which has been narrowly offset by increases in direct taxation, notably the sharp increase in corporation tax since 2001. While tax collection in India is complicated due to the size of the informal economy, the limited rise of the tax revenue-to-GDP ratio can be attributed to the hefty amounts of arrears and tax exemptions. [ 31] Although public authorities have a certain degree of reticence, most likely correlated with the stronger presence of economic interest groups (Cottet, 2011), several major tax reforms are under discussion (valueadded tax reform with the introduction of the Goods and Services Tax - GST; a reform of direct taxation with the adoption of the Direct Tax Code - DTC).

Source: Frankel et al. (2011)

[ 30] Relating to India’s trade openness policy (cf. Section 3.3).

[31] I n 2009/2010, tax arrears arising from taxpayers who either refuse or encounter difficulties to pay their direct taxes account for 67% of taxes actually collected and 2.8% of GDP (ADB, 2012). Particularly high tax concessions involve excise duty and customs duty and represented foregone revenue of around 9% of GDP in 2009/2010 (idem).

/ The challenges of India’s economic policy/

35

Figure

38

A f i s c a l fe d e ra l i s m t h at co m p l i c ate s improvements to the quality of public expenditure

Relatively low fiscal pressure

(Central Government tax revenue as % of GDP) 30 25 20 15 10 5

South Asia

China

India

Indonesia

LMICs

World

Russia

Brazil

Turkey

South Africa

0

Source: World Bank (WDI).

Figure

39

A slight increase in fiscal pressure since the late 1980s (% of GDP) ■ 1950-1951

■ 1987-1988

India’s federal structure is not without effect on the public authorities’ capacity to improve the quality of public expenditure. In fact, centre-state transfers (cf.

Box 12) and debt servicing (borne mainly by the ce nt re ; Cottet, 2011) – which are two types of expenditure that are difficult to modify in the short term – account for 60% of central government expenditure (cf. Table 11). This relatively rigid structure of central government spending implies that public deficits can only be controlled at the expense of other potentially growth-inducing public expenditures, such as capital investment, which are in fact those that produce the largest multiplier effect on growth (Jain and Kumar, 2013). This can be illustrated not only by India’s low public investment rate (less than 8% of GDP in 2012) particularly compared with China (nearly 22% of GDP), [ 32] but also by its relative vulnerability to cyclical swings, as recent budgetary decisions have shown. Nevertheless, despite these strong constraints on expenditure, major reforms have been undertaken, particularly in the area of energy subsidies.

■ 2012-2013

20 18 16 14 12 10 8 6 4 2 0 Total tax revenue

Direct taxes

Indirect taxes

Central taxes (before transfers to States)

States’ own revenue

Source: MoF.

[32] India’s rate of public investment is nonetheless close to the LMIC rate according to the World Bank.

36

© AFD / Macroeconomics and Development / September 2014

Table

11

Central government 2012/2013 accounts: nearly 60% of revenue is allocated to “unavoidable” expenditures % total revenue

% total revenue (net of transferred taxes)

% total expenditure

82 - -

Gross tax revenue Tax revenue, net of transferred taxes Other current revenue

- 77 12 16 -

Non-debt capital receipts

6 7 -

Total revenue

100 - -

Total revenue, net of transferred taxes

- 100 23

Redistribution of tax revenue

- 17

9 12 7

Transfers and loans to states Interest payments

24 32 18

Irreducible expenditure

57 44 41

Other current expenditure

64 84 46

Capital expenditure

18 23 13

Total expenditure

-

- 100

Note: in the first column, the share of tax revenue transferred to the states is counted as an expenditure and not as a negative receipt (contrary to the presentation used by the MoF, shown in the second column).

Source: MoF, authors’ calculations.

Box

11

Centre-state transfers: a system core to India’s regional cohesion, but with certain limitations

A relatively complex system In India, there are three types of resource transfers from the centre to the states are of three kinds (Varshney, 2013): - Fiscal transfers corresponding to the states’ share of central taxes and determined by the Finance Commission, which meets every five years. These t ran s fe rs i m p o se no co ndi ti o ns regardi ng the ir use (it involves “simply” handing back resources) and their purpose is mainly redistributive since the poorest states receive proportionally more than the others.

- G ra nt s a n d l o a n s d e f i n e d by t h e P l a n n i n g Commission, which is a permanent body, and disbursed under the Five-Year Plans drawn up by the Commission. Most of these transfers (about 80%

in 2012/2013) are conditional and require the states’ own contributions (matching grants).

- Tra n s fe rs for va rious proje cts or progra m m es wholly financed by central government (centrally sponsored schemes).

Since the late 1990s, there has been some degree of stabilisation of centre-state transfers as a share of GDP (around 5.5% of GDP in gross terms), following a phase of decline nonetheless (cf. Figure 40). The composition of these transfers, however, has changed significantly: in particular, transfers in the form of loans have sharply decreased due to changes in the public sector’s borrowing framework (see above), which has mainly benefited tax redistribution (cf.

Figure 41).

/ The challenges of India’s economic policy/

37

Figure

Figure

40

Composition of centre-state transfers: loans have almost been phased out in favour of tax redistributions (% total)

Centre-state transfers: decreasing amount despite some stabilisation since the 2000s (% of GDP)

Tax redistribution (FC*) Special programmes (PC**) Grants excluding special programmes (PC) Loans (gross)

Gross transfers (% of GDP) Transfers net of debt service (%of GDP) 8 7

60

6

50

5

40

4

30

3

20

2

10 1990-91

1994-95

1998-99

2002-03

2006-07

41

2010-11

0 1990-91

1994-95

1998-99

2002-03

2006-07

2010-11

Sources: RBI (2014b), authors’ calculations. * Finance Commission, ** Planning Commission.

Sources: RBI (2014b), authors’ calculations.

The redistributive dimension is very limited In India, the capacity of federal transfers to promote a degree of convergence among states seems somewhat limited. Although the amounts transferred are considerable, the large spatial inequalities in India (compared to other federations) curb the possibilities of inter-state equalisation, unless the amounts were to be significantly increased. Whereas for advanced economies the ratio between the richest and poorest countries’ GDP per capita does not generally exceed 1.5-2 (Kelkar, 2010), in India it is higher than 8.

Moreover, if, as we have seen, redistribution constitutes the basis for the rationale underpinning the design of some transfers, others have an allocative function and require that states contribute their own resources. Given the limited (negative) elasticity of these transfers to the development level of states, Rodden (2009) estimates that the redistributive capacity of transfers in India is close to 0, [ 33] a result that is also established for other federations (Argentina, Brazil and the United States).

An effect of the states’ financial dependency on the centre Although the level of devolution is relatively high in India in terms of expenditure implementation (if the effect of transfers is eliminated, the share of public expenditure implemented by the states was 53% in 2012/2013 [ 34] ), the states remain highly dependent on transfers from the centre, which represented over 40% of their resources in 2012/2013 (cf. Table 12). According to Purfield (2004) and as observed in other federations, this dependency has disincentivising effects on the states both in terms of fiscal deficit reduction and structural reform.

[33] In the sense that the states’ relative revenue before transfers is almost perfectly correlated with the states’ relative revenue after transfers.

[34] The relationship between the states’ expenditure to total public expenditure from which centre-state transfers are deducted.

38

© AFD / Macroeconomics and Development / September 2014

Table

12

States’ accounts 2012/2013: high dependency on transfers from the centre % total revenue

% total expenditure

Own tax revenue

74 -

Own tax revenue + transferred taxes

44 -

Transfers from Centre and Funds (excl. tax redistrib.) 20 Other current revenue

6 -

Total revenue

100 -

Interest payments

12 10

Other current expenditure

84 72

Capital expenditure

20 17

Total expenditure

- 100

Note: in the first column, the share of tax revenue transferred by the centre is considered as a transfer (contrary to the presentation adopted by the MoF, which includes it under tax revenue).

Source: MoF, authors’ calculations

3.3.

E x te r n a l

a cco u nt s : re d u c i n g energy dependence and improving the quality of external financing

exporter of goods, and the 7th largest importer and exporter of services. India’s market share of world trade i n go o d s a n d s e r v i ce s re a ch e d 2 . 3 % i n 2 0 1 2 , compa re d with less than 1% in the early 2000s; the Indian Government is targeting a market share of 5% of world trade in goods and services by 2020.

3.3.1.

A n u n s u s ta i n a b l e d e te r i o rat i o n i n t h e balance of payments that calls for structural measures

Figure

42

An increasingly open economy

An increasingly open economy In a quarter of a century, India has experienced a real revolution of its trade relationships with the rest of the world: its openness rate has more than quadrupled over this period, reaching 55% of GDP (cf. Figure 42).

No other “large country” has seen such extensive progress and India, which in 1987 was the most closed of the large emerging economies, now has an openness rate in line with the norm (cf. Figure 43). India’s economy is significantly more open than its neighbours Bangladesh and Pakistan, which are smaller economies and therefore expected to have a proportionately higher level of international trade. According to the World Trade Organisation (WTO, 2013), India is now the world’s 10th largest importer and 17th largest

Imports + exports of goods / GDP Imports + exports of goods and services / GDP 60% 50% 40% 30% 20% 10% 0% 1987-88

1991-92

1995-96

1999-00

2003-04

2007-08

2011-12

Sources: RBI, authors’ calculations.

/ The challenges of India’s economic policy/

39

Figure

Figure

43

Growing exports of goods and services

Openness rate now in line with the average for large emerging economies (GDP pp; trade

(GDP pp)

in goods) ■ 1987

■ ■ ■ ■

■ 2012

60 50

Services ■ Petroleum products Other manufactured products ■ Jewellery Textile products ■ Primary commodities Chemical, machinery, vehicles, electronics

25 %

40

20 %

30 20

15 %

10

10 %

Turkey

South Africa

Pakistan

Indonesia

China

Brazill

India

0

Sources: RBI, authors’ calculations.

This structural evolution reflects the shift in India’s economic policy following the 1991 crisis (India joined the WTO in 1995) and was designed to increase the share of the external sector in the economy. Trade policy was overhauled (by simplifying procedures, removing quantitative restrictions and substantially reducing customs duties) and measures were taken to encourage exports. The average rate of customs duty now stands at 13.7% (WTO, 2013). As a result of its greater openness, India’s economy has also become more exposed to global business cycles. It benefited directly from the period of strong global growth between 2000 and 2007, which resulted in an increase in global demand and boosted its export sector. On the other hand, in the global recession following the 2008 financial crisis, the continuance of a steady growth rate for the Indian economy – together with the increase in imports that is mechanically associated with this – has required, other things being equal, gains in international market share to avoid destabilising external accounts.

An export sector positioned on buoyant markets India’s exports are relatively diversified, both in terms of the goods and services exported and the geographic

40

44

5% 0% 1992-1993

2002-2003

2012-2013

Sources: RBI, authors’ calculations.

destination. Although India’s economy is more vulnerable than in the past to changes in the global economy, this diversification reduces the likelihood and size of destabilising shocks, whether at regional or sector level.

All of the main exports have seen significant growth over the last two decades (except textiles) and the export sector’s share in the Indian economy has tripled over the period, reaching 24% of GDP (cf. Figure 44).

In 2012/2013, the export of primary commodities, mainly agricultural products (rice, wheat, cotton, etc.), accounted for 11% of total goods and services exports.

Exports of manufactured products (42% of the total) include medium-/high-tech products such as plant machinery, electronics and vehicles. India is a major international player in two sectors in particular: chemicals (especially drugs) and jewellery. Exports of refined petroleum products have also increased sharply in recent years. However, the troubled textile sector points up India’s weakness in its positioning of unskilled labour-intensive products: it has lost market share internationally to countries such as Bangladesh, especially due to tighter labour legislation (cf. Box 7).

© AFD / Macroeconomics and Development / September 2014

Another striking feature of India’s export sector is the large proportion of services exports, which now account for a third of total exports; this is an almost unique case among the emerging countries, along with the Philippines. The two main types of services exported are IT services (44%) and business services (18%); export of transportation and travel (50% of global services exports; UNCTAD, 2013) only account for 28% of India’s exports. The trade in services is growing significantly faster than the trade in goods (5% and 2.1% respectively in 2013 according to the United Nations Conference on Trade and Development – UNCTAD) and India has successfully positioned itself as a major global player in the sector, with a market share of 3.1% of global services exports in 2012 (more than three times the 2000 level).

India’s exports are mostly oriented towards emerging and developing markets. Countries in the Organisation for Economic Cooperation and Development (OECD) now account for only 34% of India’s goods exports [ 35] (12% to the USA and 16% to the European Union) compared with over 50% in the early 2000s. Exports to other Asian countries account for 29% (9% to China/ Hong Kong and 5% to countries in the South Asian Association for Regional Cooperation [SAARC]). The diversification of India’s export markets is evidenced by the fact that Gulf countries represent 16%, African countries 8% and Latin American countries 5%. This broad export diversification mitigates the country’s vulnerability to regional shocks. The eurozone crisis, for example, has not had a significant direct impact on India’s economy. Indian exporters thus target regions that are still experiencing the highest levels of growth globally.

Figure

45

Diversified export markets (2012-2013; %) ■ OPEC* members ■ China ■ SAARC ■ Other Asia ■ Africa

5%

■ Latin America ■ Others ■ EU ■ USA and Canada ■ Other OECD

3% 17 %

8%

13 %

19 %

5% 5% 4%

21 %

* OPEC: Organization of the Petroleum Exporting Countries.

Source: RBI, authors’ calculations.

• Unsustainable deterioration in the balance of payments current account Export sector growth has not been sufficient to stave off a structural deterioration in the balance of payments current account. Since the 2008 crisis, it has recorded a deficit of more than 2% of GDP despite having remained below this level from 1991 (even showing a surplus in the early 2000s). At 4.8% of GDP in 2012/2013, the current account deficit was twice as high as the level deemed sustainable by both the RBI [ 36] and the IMF (2014a). In addition, that same year India registered the world’s third highest current account deficit by amount (more than USD88 billion), after the US and the UK (according to IMF data).

[35 ] The IMF (2014c) points out that the elasticity of India’s growth to US growth is still significant, particularly through services exports, and that India’s growth remains strongly correlated with that of advanced economies.

[36 ] Goyal (2012) concludes that a sustainable level of current account deficit is in the region of 2.4% to 2.8% of GDP.

/ The challenges of India’s economic policy/

41

The current account deterioration over the past decade stems primarily from oil and gold imports. If oil and gold are excluded, the current account has actually remained steady over the period at around 3% of GDP (cf. Figure 46). The increased energy and gold bill is due both to price effects and volume effects. Imports of petroleum products accounted for 9.2% of GDP in 2012/2013. After deducting re-exported refined petroleum products, India’s “oil product” trade deficit stood at almost 6% of GDP. This deficit has deteriorated sharply in the last 10 years (it was less than 3% of GDP until 2003/2004) chiefly due to the hike in global oil prices (unit prices rose 169% over this period according to RBI), [ 37] but also due to the volume imported to meet increases in domestic energy demand. India’s economy is structurally dependent on external sources for its energy needs and this dependence is expected to rise in the coming years. The country has few indigenous energy resources, except for coal, which remains underexploited, while the country’s energy intensity (currently low) is likely to grow. In this context, if there is no policy change, energy costs will continue to weigh heavily on India’s balance of payments in the years to come. Additionally, the high level of net oil imports in the balance of payments continues to expose India to price shocks on petroleum products. [ 38] Gold imports have also risen sharply since 2008 and have contributed to the current account imbalance.

The increasing preference for gold shown by India’s economic actors is mainly due to their wish to hedge against inflation in an environment of negative real interest rates and appreciating international gold prices (cf. Box 12). This phenomenon may also be illustrated by the decline in household financial savings since 2009/2010.

Figure

46

The energy and gold trade balances explain the deterioration in the current account (GDP pp) ■ Trade balance – petroleum products ■ Trade balance – precious metals Current account Current account excluding oil and precious metals 8% 6% 4% 2% 0% -2 % -4 % -6 % -8 % 2000-01 2002-03

2004-05

2006-07 2008-09

2010-11

2012-13

Source: RBI, authors’ calculations.

• Policy measures effective in the short run, but apparently inadequate in the medium and long run Against this backdrop, confronted by the financial turmoil of summer 2013 (following the announcement of the gradual normalisation of US monetary policy) with a sudden sharp depreciation of the rupee (about 10% in August 2013), the Indian Government introduced aggressive measures to reduce the current account deficit (but also facilitate financing; see below).

These included first of all a tightening of monetary policy to reduce inflation and make gold investments less attractive. Measures targeting gold imports were also adopted (higher duties, quantitative restrictions).

Lastly, the aforementioned tightening of fiscal policy contributed to this effort to reduce the country’s domestic savings deficit. These measures proved effective in the short term, as the current account deficit fell to 1.2% of GDP in 2013/2014, largely due to

[37] R esult of the net increase in commodity prices: India’s terms of trade have been declining for ten years. In addition, the depreciation of the nominal effective exchange rate has far from offset this trend, and the volume effects (associated with increased price competitiveness generated by this depreciation) appear to be inadequate (cf. Bhanumurthy and Sharma [2013] for the effects of exchange rates on manufacturing exports).

[38] The hike in oil prices brought about by the first Gulf War was one of the catalysts of the 1990/1991 crisis.

42

© AFD / Macroeconomics and Development / September 2014

a sharp decline in gold imports (but also a recovery of exports). However, this initial success needs to be confirmed: firstly, it is conceivable that some of the improvements observed were overstated, given the rise in illegal gold imports; also, these measures, which had negative knock-on effects for the country’s jewellery

Box

India’s rising “gold bill”: external causes, as well as structural internal causes

12

The predilection of India’s economic players for holding gold is nothing new. John Maynard Keynes compared this atavism to “the ruinous love of a barbaric relic” and the macroeconomic consequences of this “fondness for gold” are still significant today.

With a demand of 975 tonnes in 2013, India amassed a quarter of global demand for gold (World Gold Council, 2014) while its domestic production is virtually nil.

India’s gold demand essentially meets three needs: (i) supplying the raw materials for the jewellery industry (which accounts for 10% of India’s goods and services exports, (ii) hoarding (in an economy that remains under-banked) and religious offerings, (iii) hedging against inflation and depreciation of the rupee. The first of these needs has no destabilising effect on the Indian economy since foreign currency revenues from exports finance the input costs. This is not the case for the other two needs, whose macroeconomic impact can be classed as a form of capital flight since they represent savings that generate a net outflow of foreign currency for the country. Demand for gold for the purpose of hoarding/religious offerings has remained fairly steady over time, rooted in the habits of Indian households, and can only be tackled as part of long-term policies to develop financial savings. The demand for gold to

Table

sector, eventually had to be relaxed in May 2014; finally, these discretionary measures do not appear sufficient to allow lasting changes in India’s major macroeconomic balances, which would require above all decreasing the dependency on external energy supplies.

13

hedge against inflation, on the other hand, fluctuates widely depending on the relative yields of different forms of investment, especially real interest rates on local currency investments.

India’s gold imports have grown significantly in recent years. In 2002/2003, they accounted for the equivalent of 0.7% of GDP, rising to 2.9% of GDP in 2012/2013 at a cost of USD54 billion. This sharp increase is the result of both price effect and volume effect. Most analytical studies concur that the rise in volume can be explained primarily by the demand for hedging against inflation: gold imports are strongly correlated with households’ inflation expectations, with a correlation coefficient of 0.83 (IMF, 2014a). For the period 2009-2013, a comparison between the yields of real gold investment and other forms of investment illustrates that gold was ex post much more profitable (cf. Table 13). The fact that India is a major player in the global market and therefore a price-maker means that this voracious appetite for gold triggers a vicious circle: strong Indian demand for gold helps to push up international gold prices, which in turn enhances the profitability of investments in gold, thereby increasing pressure on the balance of payments.

Gold’s comparative investment yields Real yield gold

Real yield real estate

Real yield term deposits

2009-2010

8.7% -0.6% -4.8%

2010-2011

10.5% 7.9% -1.9%

2011-2012

23.4% 12.8% -0.9%

2012-2013

6.5% 11.1% -4.8%

2009-2013 average

12.1% 7.7% -2.6%

Source: RBI, authors’ calculations

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43

The financial tensions in summer 2013 led the Indian Government to take measures to limit gold imports: customs duty on gold imports was raised from 4% to 10%, restrictions were placed on some traders and it became mandatory for at least 20% of each batch of imported gold to be specifically allotted to jewellery export activities. Official statistics show that gold imports decreased significantly (down 38% in USD from April–December 2012 to April–December 2013).

This fall indicates a price effect (30% reduction in gold pr i ce s d ur i n g 201 3 ), as wel l as a vo l u me e ffe ct.

However, these tariff measures led to a rise in illegal

3.3.2. Increased reliance on volatile financing flows India’s external financing requirement (EFR) has increased significantly in recent years (up 4.8 GDP percentage points over five years) to 11.5% of GDP in 2012/2013 (cf. Table 14). This trend is due (in almost equal measure) not only to the rising current account deficit, but also to the increased levels of external debt amortisation, which in turn mainly stems from increased short-term borrowing. In 2012/2013, new short-term

44

imports that amounted to around 150–200 tonnes in 2013, according to the World Gold Council (Ibid.).

Moreover, the steep rise in gold smuggling and the negative effects of the restrictive measures on the Indian jewellery sector eventually drove public authorities to relax this policy extensively in May 2014. This reversal shows that, over the medium term, only a return to positive real interest rates on local currency investments and the development of hedging instruments against inflation will shrink Indian economic actors’ demand for gold.

loans made to India (mainly trade credits relating to import transactions) by foreign suppliers or banks amounted to 6.7% of GDP compared with 3.6% of GDP five years previously. The rise in these payment facilities reflects de facto India’s growing integration into the global economy and is not a priori a source of structural weakness. However, in times of financial turmoil, suppliers become more averse to short-term risk and prefer cash payments. Overall, even after excluding trade-related credit, the EFR has increased significantly in recent years.

© AFD / Macroeconomics and Development / September 2014

Table

14

External financing needs and what is covered (GDP pp) 2012-2013

2012-2013

2012-2013

2012-2013

2012-2013

A – EFR (1+2)

-6.7 -7.3

-7.5 -10.7 -11.5

(1) Current account

-2.3 -2.8 -2.8 -4.2 -4.8

(2) Amortisation on external debt

of which short-term debt (trade credit)

-4.4 -4.5 -4.7 -6.5 -6.7 -3.6 -3.3 -3.8 -5.1 -5.5

B – EFR coverage (3+8+12)

5.0 8.3 8.4 10.1 11.6

(3) Debt-creating flows (4+5+6)

5.1 5.4 6.4 7.5 8.4

(4) Official borrowing

0.4 0.4 0.5 0.3 0.3

(5) Medium- and long-term commercial borrowing

1.2 1.1 1.4 1.7 1.5

(6) Short-term borrowing

3.4 3.9 4.5 5.5 6.7

(8) Non-debt-creating flows (9+10+11)

0.2 2.7 1.7 1.7 2.3

(9) Net FDI

1.8 1.3 0.7 1.2 1.1

(10) Flux Net portfolio flows

-1.1 2.4 1.8 0.9 1.5

(11) Others

-0.5 -1.0 -0.7 -0.4 -0.3

(12) Banking capital

of which non-resident deposits

-0.3 0.2 0.3 0.9 0.9 0.4 0.2 0.2 0.6 0.8

C – Errors and omissions

0.0 0.0 -0.2 -0.1 0.1

D – Variation in reserves (incr.: - / decr.: +)

1.6 -1.0 -0.8 0.7 -0.2

Sources: RBI, authors’ calculations.

This increase in India’s external financing needs has not been a major macroeconomic issue as it has arisen in an international environment that supports capital flows to emerging countries. Over the past decade, low interest rates and anaemic growth in the more advanced economies, unlike the economic momentum and promising returns in emerging countries, have led to increasing diversification of global savings in favour of emerging countries. India has therefore experienced very large net capital inflows during this period (cf.

Figure 47), enabling an accumulation of foreign currency reserves (see below). In addition, the Indian Government’s prudent strategy regarding external debt has helped to keep the country’s total external debt-to-GDP ratio at a moderate level by international comparison (cf. Box 13).

Nonetheless, the structure and evolution of India’s financial account exhibit some weaknesses. An analysis

of the composition of these net capital inflows points to low quality financing of the country’s external financing needs. Net FDI (a financing source viewed as stable) seems low (an average 1.1% of GDP over the last four years) and lower than the more volatile portfolio flows (1.6% of GDP). The use of mediumand long-term concessional public debt is now marginal (0.3% of GDP). At the same time, Indian companies are making greater use of medium- and long-term commercial borrowing , which is more likely to be impacted by a turnaround in market confidence. Finally, bank financing has grown, especially non-resident deposits, representing 0.8% of GDP for the year 2012/2013. During periods of international financial tensions, these net capital inflows contract or even dry up. Two such episodes have occurred within the last decade: the first in 2008/2009 in the thick of the global financial crisis and again since 2013, with the Fed’s announcement that it would gradually be tapering

/ The challenges of India’s economic policy/

45

its unconventional monetary policy (starting from January 2014). Finally, since 2008/2009, the accumulation of foreign currency reserves has been significantly reduced, given that capital inflows only just cover the current account deficit (cf. Figure 48).

Figure

47

Net inflow of volatile capital (USD billions) 120 100 80 60 40 20 0 2002-2003

2005-2006

2008-2009

2011-2012

Source: RBI, authors’ calculations.

Figure

48

2008/2009 marks a disruption of the balance of payments equilibrium (GDP %)

■ Current account ■ Capital account and financial account ■ Reserves (-)

In this context, India’s economy has become far more vulnerable to a reversal of capital flows than was the case a few years ago, which explains the turmoil that occurred in summer 2013. On top of the measures taken to reduce the current account deficit (see above), the Indian Government adopted a series of additional measures focussing on financial flows. Notably, the RBI gave local banks (from August to November 2013) access to concessional currency swaps in order to attract deposits from non-resident Indians and encourage banks to make use of external currency financing. [ 39] These favourable conditions were a great success and helped to keep capital and financing accounts in surplus, despite capital outflows from portfolio investments and a contraction of short-term credit. Capital inflows from non-resident deposits reached USD35 billion for the period March to December 2013 (triple the previous year’s level). In addition, the flexible exchange rate regime helped to prevent an outright crisis and to absorb the shock without the drawing significantly on foreign currency reserves, contrary to what happened during the 1991 crisis (tumbling foreign currency reserves that drove the RBI to devalue the rupee by 30% in 3 days).

However, RBI’s adequate handling of this financially strained period should not gloss over the fact that the measures taken are simply short-term steps to address any abrupt change in market conditions, but they are not a substitute for a lasting reduction of the current account deficit and an improved quality of current account financing , especially through greater openness to FDI.

12 10 8 6 4 2 0 -2 -4 -6 2005-2006

2007-2008

2009-2010

2011-2012

Source: RBI, authors’ calculations

[39] T he RBI charged significantly less than the market rate for these swaps and carried the associated foreign exchange risk on its balance sheet.

46

© AFD / Macroeconomics and Development / September 2014

Box

13

Historically high capital inflows and prudent public debt policies have resulted in comfortable external liquidity and solvency ratios

Despite the deterioration of the current account and increased use of debt-creating capital flows, India’s solvency and external liquidity indicators remain satisfactory. At nearly USD300 billion, foreign currency reserves remain at a comfortable level, although they have shrunk somewhat in months of imports in connection with the turbulence in recent years (cf.

Figure 49). The reserves equate to 6 months of imports, 150% of short-term debt, 19% of M2 money supply and 145% of the IMF composite indicator for assessing a country’s target level for reserves. [ 40] This should e n a b l e I n d i a to d e a l w i t h a ny f u r t h e r f i n a n c i a l turbulence.

At 21.2% of GDP at the end of March 2013, India’s external debt level is moderate compared with other

Figure

Figure

49

Comfortable reserve levels

50

External debt is mainly private (2012-2013)

■ Reserves in USD billions Reserves in months of goods and services imports (RH scale) 350

14

300

12

250

10

200

8

150

6

100

4

50

2

0

emerging countries and does not represent a major source of weakness for the country’s economy. Public debt is only a fifth of total external debt and the private sector is the main generator of external debt, t h ro u g h t rad e c re d i t , m e d i u m - a n d l o n g - te r m co m m e rc i a l borrowings and foreign currency bond issues (cf. Figure 50). The latter have developed in recent years to the point that it could pose a problem for company balance sheets exposed to currency risk.

N ote t h e i n c re a s i n g ro l e p l aye d by n o n - re s i d e nt deposits in India’s external debt: already accounting for 18% of external debt at the end of March 2013, they could exceed a quarter of total external debt following actions taken in the second half of 2013 to encourage their use.

■ ■ ■ ■ ■

MT and LT private debt (bleu) Non-resident deposits (jaune) Other LT private debt (bleu) ST debt (private and public) MT andLT public debt (orange)

25 %

20 %

0 Dec. Dec. Dec. Dec. Dec. Dec. Dec. Dec. Dec. Dec. Aug. 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2003

5%

Source: RBI, authors’ calculations.

The net international investment position – which m e a s u re s t h e d i ffe re n ce b et we e n a s s et s h e l d by Indians (resident) abroad and assets held by foreigners (non-resident) in India – is negative at 40% of GDP, placing India at a level comparable to Brazil, Indonesia and Mexico, and does not appear to be particularly problematic.

18 %

32 %

Source: RBI, authors’ calculations.

[40] See the IMF document “Reserve Adequacy Assessment” (2014).

/ The challenges of India’s economic policy/

47

Conclusion

After many years of strong economic growth, India is now facing a marked slowdown in activity, which is more pronounced than in other large emerging countries. This slowdown, along with relatively disappointing social policy outcomes, raises a host of economic policy challenges for the Indian Government.

Boosting growth as well as improving inclusiveness involves notably the easing of supply-side constraints and some changes in Indiaâ&#x20AC;&#x2122;s sectoral positioning.

Likewise, it would also be desirable to increase the fiscal space to meet infrastructure investment needs, at the same time pursuing ambitious social policies to

48

reduce the high poverty level. Finally, in a still uncertain global environment where the assumption of efficient financial markets has shown its limitations (Aglietta et al., 2014), mitigation of Indiaâ&#x20AC;&#x2122;s vulnerability to volatile external financing flows would appear necessary. This objective will require policies designed to reduce energy dependency, further openness to FDI and a higher rate of household financial savings. These are the many economic policy challenges that the Indian Government must overcome in the medium and long term to ensure that this huge democracy continues to converge with the most advanced economies.

Š AFD / Macroeconomics and Development / September 2014

List of acronyms and abbreviations AMR

Division Analyse macroéconomique et risque pays (AFD)

AAP

Aam Aadmi Party

AFD

MRP

Mixed Reference Period

NCAER

National Council of Applied Economic Research

Agence Française de développement

NREGA

National Rural Employment Guarantee Act

EFR

External financing requirement

NSSF

National Small Saving Fund

BJP

Bharatiya Janata Party

NSSO

National Sample Survey Office

BLD

Bharatiya Lok Dal

OECD

BRICS

Brazil, Russia, India, China, South Africa

Organisation for Economic Cooperation and Development

CAG

Comptroller and Auditor General

OPEC Organization of Petroleum Exporting Countries

CCI

Cabinet Committee on Investment

PDS Public Distribution System

CGDev

Center for Global Development

GDP Gross domestic product

CPI

Consumer price index

NPL Non-performing loan

CSO

Central Statistical Office

pp percentage points

DCRF

Debt Consolidation and Relief Facility

PPP Purchasing power parity

DHS

Demographic and Health Survey

RBI Reserve Bank of India

DSS

Debt Swap Scheme

RSBY Rashtriya Swasthya Bima Yojana

DTC

Direct Tax Code

RTE

EU

European Union

GFCF

Gross fixed capital formation

SAARC South Asian Association for Regional Cooperation

FRBMA

Fiscal and Responsibility Budget Management Act

SBI State Bank of India

FRL

Fiscal Responsibility Laws

FSI

Financial soundness indicators

GST

Goods and Services Tax

FDI

Foreign direct investment

HDI

Human Development Index

UNCTAD United Nations Conference on Trade and Development

IDEA

International Institute for Democracy and Electoral Assistance

UNDP United Nations Development Programme

ILO

International Labour Organization

IMF

International Monetary Fund

INC

Indian National Congress

LMIC

Lower-middle-income country

MG-NREGA

Mahatma Gandhi National Rural Employment Guarantee Act

MoF

Ministry of Finance

Right of Children to Free and Compulsory Education

SNP Supplementary Nutrition Programme ST Short term TFP Total factor productivity UID Unique Identification

UPA

United Progressive Alliance

USD US dollar VA Value added WDI World Development Indicators WPI Wholesale price index WTO World Trade Organization

/ The challenges of India’s economic policy/

49

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MACRODEV (‘’Macroeconomics and Development’’)

Directeur de la publication : Anne PAUGAM

This collection was launched by AFD’s Research Department to present the work produced in the field of development macroeconomics by AFD’s Macroeconomic and Country Risks Analysis Unit (RCH/AMR) and AFD Group economists. It publishes studies that focus on countries, regions or development-related macroeconomic issues.

The analyses and conclusions in this document are the sole responsibility of the authors, and do not necessarily reflect the viewpoints of the Agence Française de Développement or its partner institutions.

Directeur de la rédaction : Gaël GIRAUD Translator: Gill GLADSTONE

© AFD / Macroeconomics and Development / September 2014

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PLANNING COMMISSION (2005), “Performance Evaluation of Targeted Public Distribution System (TPDS)”, March.