Report No. 31783-IN India Economic Growth and Poverty Alleviation in Tamil Nadu Notes on Selected Policy Issues March 28, 2005 Poverty Reduction and Economic Management South Asia Document of the World Bank TABLE OF CONTENTS OVERVIEW ................................................................................................................................................................ I EXECUTIVESUMMARY .................................................................................................... ............................... ...I11 I. DEVELOPMENTOUTCOMESANDCHALLENGES ............................ ....................................................1 DEVELOPMENTOUTCOMES ......................................................................................................................... 1 DEVELOPMENT CHALLENGES..................................................................................................................... 4 REFORMAGENDA..... ...........8 11. ACHIEVING FISCAL CORRECTIONAND STABILIZATION .............................................................. 14 TAMIL NADU'S FISCALREF0................................................................................................................. 14 INITIAL OUTCOME OFFISCAL REFORM ....... ....... MEDIUM-TERM ADJUSTMENT ............. PATH ................................................................................27 FISCALSUSTAINABILITY ANDRISKS................................ 111. IMPROVINGINVESTMENTCLIMATE FORMANUFACTURINGAND SERVICES ......................32 REMOVING REGULATORY BURDENS ......................................................................................................... 32 RESOLVINGINFRASTRUCTURE BOTTLENECKS ..................... INSTITUTIONALIZING PUBLICANDPRIVATESECTORDIAL0 IV. REINVIGORATINGAGRICULTURE GROWTH .................................................................................... 41 SALIENTFEATURESAGRICULTU OF RE............. .............................................. 41 EFFICIENT WATERRESOURCE MANAGEMENT ............................................42 CHALLENGES OFAGRICULTURE DIVERSIFICATION ....................... ............................. ........ ~ V. IMPROVINGPUBLIC ADMINISTRATIONAND ENHANCING SERVICEDELIVERY ..................48 RATIONALIZINGTHE ROLEOF GOVERNMENT ......................................................................................... 48 STREAMLINING DECISIONMAKING..................... . 49 IMPROVINGTHE STABILITY OF STAFFTENURE ......................................................................... 49 IMPROVING CRITICALSERVICESWITH A LARGE PUBLICINTERFACE.................................................... 50 PROCUREMENTREFORM.............................................. 50 RIGHTTOINFORMATION ..................................................... 51 ENFORCINGANTI-CORRUPTION ............................................................................................................... 51 VI. STRENGTHENINGPOVERTY MONITORINGAND EVALUATION .................................................. 53 VII. REFORM CHALLENGES AND RISKS ..................................................................................................... .55 ANNEXES ANNEX I. A FUNCTIONAL REORGANIZATION SCHEMEFORTHE COMMERCIAL TAX DEPARTMENT 61 ANNEX 2. BUDGETAND FINANCIAL MANAGEMENT REFORMS 64 ANNEX 3. REFORMSTO IMPROVETHE INVESTMENT CLIMATE 69 FISCALDATA ANNEX 72 REFERENCES 77 Economic Growth and PovertyAlleviation in Tamil Nadu Noteson Selected PolicyIssues Preface This volume presents a synthesis o f five policy notes prepared by the World Bank staff in collaboration with the Government of Tamil Nadu to support its reform program between 2002 and 2004. The five notes span fiscal reform and sustainability, improving investment climate, agnculture development, governance challenges, and poverty profile. An overview o f the main messages o f the five notes i s also presented. The report reflects the status o f policy dialogue up to March 2004 with a few selected updates. Some caveats are inorder. ACKNOWLEDGEMENT The notes were prepared by a team ledby Lili Liu and Mohan Nagarajan, under the overall guidance o f Sadiq Ahmed and Michael Carter, and with advice from Ijaz Nabi and Stephen Howes. The peer reviewer i s Shahid Yusuf. Major contributions to the notes are listed below. Ahmad Ahsan provided valuable comments on the report. Fiscal Reform and Sustainability: Lili Liu, Mohan Nagarajan (co-task managers), Michael Engelschalk and Tuan Minh L e on tax policy and administration, Anand Rajaram on expenditure reform, Mohan Gopalakrishnan and Peter Dean on financial management and accountability, Elena Ianchovichina on fiscal sustainability, Yee Mun Sin on pension reform, Rajesh Sinha and Rohit Mittal on power, and Smita Kuriakose on fiscal data. Improving Investment Climate: Lili Liu, Simon C. Bell and Abha Joshi-Ghani (task mangers), Taye Alemu Mengistae on investment climate survey and analysis, Andrew Singer on regulatory constraints, Nagavalli Annamalai on labor market reform, Michael Engelschalk and Tuan MinhL e on tax policy and administration, David Dowall on urban land market, Rajesh Sinha and Rohit Mittal on power, Amab Bandyopadhyay on roads, Abha Joshi-Ghani on water, and Ted Liang on ports. Agriculture Development: Paul A. Dorosh and Mona Sur. Governance Challenges: Vikram K. Chand. Poverty ProJile: Tara Vishwanath (coordinator), Peter F. Lanjouw (poverty profile), and Raji Jayaraman (village studies). Shahnaz Sultana Ahmed, Jyoti Sriram, Thelma Rutledge, and Oxana Bricha provided document preparation. The policy notes were developed in consultation with the Government o f Tamil Nadu. The counterpart was led by Mr. N. Narayanan, Finance Secretary and Development Commissioner. Officials in the Finance Department, Industry Department, Agriculture Department, Public Administration Department, Labor Department, Tamil Nadu Electricity Board and numerous other government departments, agencies and statutory boards provided unstinted help during the preparation o f the report. Special thanks are particularly due to Mr. L. Krishnan, Special Secretary, Finance Department, Mr. Ashish Vachhani, Deputy Secretary, Finance Department and Mr. Brajendra Navnit, Deputy Secretary (Budget) for their unstinted generosity with all manner o f data and information. As always any shortcomings lie squarely withthe authors. We are also grateful to the large number o f enthusiastic participants, too numerous to name, who participated in the workshop in Chennai held in October 2004. Their comments were all welcome. We are especially thankful to Professor Rajah J. Chelliah, Chairman, Madras School o f Economics, Dr.V. K. Natraj, formerly, Director o f the Madras Institute o f Development Studies, Mr. Subhash C. Garg, Joint Secretary, Department o f Expenditure, Ministry o f Finance, Government o f India and Mr.B. Santhanam, Saint Gobain Glass India Ltd. for their support and perceptive comments. Economic Growth and PovertyAlleviation inTamil Nadu Noteson Selected Policy Issues OVERVIEW 1. Tamil Nadu has emerged as the fifth largest economy inIndia (its populationo f 62 million i s the seventh largest). Its GSDP i s about US$38 billion at official exchange rate or over US$lOO billion based on purchasing power parity. Tamil Nadu has achieved solid development outcomes, with economic growth higher, and poverty reduction faster, than the India average inthe 1990s. It i s one o f India's most urbanized states, with the thirdhighest Human Development Index (HDI) among 29 states. It also has an educated, hard working and disciplinedworkforce, and a capable civil service. 2. But Tamil Nadu has an unfinished development agenda. The state has a relatively highpoverty incidence o f about 20% and intra-state disparities in progress toward the attainment o f the Millennium Development Goals (MDGs). A fiscal crisis that peaked in 1999/00-2000/01 and slowdown in economic growth since the late 1990s threaten the prospects for sustained poverty reduction. Repeated droughts and growing water shortages heighten the importance o f structural transformation that would reduce the vulnerability o f the economy to periodic droughts through fluctuation in agriculture and its spillover to other sectors, and make available scarce water resources to higher value-addition industrial and service sectors. The faster growth of these two sectors would help absorb agriculture's surplus labor and reduce highunemploymentrate o fthe state. 3. Such structural transformation must be underpinned by fiscal adjustment to put public finances on a sustainable path, while at the same time reorienting public spending from consumption to growth- enhancing and poverty-reducing spending in critical infrastructure and social services. Power sector reforms to reduce the sector's claim on fiscal resources and improve power supply i s a high priority. Equally important are enabling investment climate improvement to promote private investment in manufacturing and services, policies and institutional reforms to encourage agriculture diversification to highvalue andless water-intensive crops, andimprovinggovernance for service delivery. 4. Spurred by the mounting fiscal crisis and slowing growth, the Govemment o f Tamil Nadu (GoTN) started implementing wide-ranging fiscal and structural reforms from late 2001 to 2003104. Though a late comer, Tamil Nadu's fiscal reform proceeded at a rapid pace that stemmed the fiscal decline. Several reforms were bold and path breaking both inthe context o f the past history o f the state, and in the national context. However, fiscal policy reversals by the GoTN in areas such as electricity tariff, the public distribution system and user charges - in the aftermath of electoral losses in the April- May 2004 national elections -have the potential o f increasing the revenue (current) and fiscal deficit and jeopardize the gains made thus far, threatening fiscal consolidation and the credibility of the Medium Term Fiscal Program (MTFP). Tamil Nadu has little choice but to return to the path o f fiscal consolidation if it i s to meet its development goals.' 5. Tamil Nadu was struck by a massive tsunami on December 26, 2004 leading to tragic loss of 8,010 lives and loss of livelihood of 400,000 families. 130,000 families were displaced. The Tamil Nadu government has estimated the financial requirements for relief and rehabilitation to the victims o f this massive human tragedy and affected infrastructure at Rs. 4,800 crore. Rehabilitation and restoration of livelihood i s expected to be spread over three years. This report was written before the tsunami struck Tamil Nadu. An assessment of the economic and fiscal impact o f the tsunami has therefore not been 'Tamil Nadu's tenth plan (2002-2007) envisages a real economic growth rate o f 8%. The Plan's goal i s to make Tamil Nadu the best state inthe country and provide opportunities for a healthy and productive life for all. factored into this report. Preliminary estimates o f the fiscal impact on the state's finances o f the expenditure on tsunami relief and rehabilitation for 2004105 are placed at 0.2 percent o f GSDP and over the next three years the impact is estimated to be 0.7 percent o f GSDP each year. However, the actual fiscal impact on Tamil Nadu will depend on the nature o f the relief assistance provided by the Government o f India to the GoTN and how much o f that will be through the state's budget andor through banks and cooperative institutions. To the extent that a grant element will dominate central government assistance to tsunami affected states to meet the cost o f rehabilitationthe fiscal impact on the state will be minimized. Some o f the assistance will be passed through to the state budget, such as central govemment subsidy to fishermen to obtain loans from commercialbanks to repair and buy boats. For instance out o f Rs. 2,347 crore assistance announced recently by the central government for purchase of fishing vessels and nets grants o f only Rs. 441 crore would be routed through the Tamil Nadu government whereas the rest i s to be provided as soft loans by commercialbanks. 6. The other event that will have a great bearing on state governments' finances over the next five years beginning 2005/06 i s the Twelfth Finance Commission's (TFC) awards for the period 2005/06 to 2009/10. The TFC has fixed Tamil Nadu's share in the total divisible pool o f central taxes at 5.305% as opposed to the prevailing 5.385%, a marginal decrease. But states' share inthe centre's total divisible tax pool has been increased from 29.5% to 30.5%. Tamil Nadu's effective share i s therefore unaltered at 1.6% o f central taxes. The total devolution o f central taxes to Tamil Nadu over the five year period i s estimated by the TFC at Rs. 32,553 crore. The TFC has done away with normal central loan assistance for state plans in favor o f market borrowings. Tamil Nadu i s not affected by this change. The TFC also recommended debt relief to the states in the form o f restructuring o f all central loans with state governments' as o f March 31, 2004 outstanding as o f March 31St,2005. The loans will be consolidated and rescheduled at 7.5% interest rate repayable over twenty years. This has been made conditional on states' enacting Fiscal Responsibility Legislation which Tamil Nadu govemment already has and i s therefore straightway eligible for debt restructuring. As a result, Rs. 6,872 crore o f outstanding central loans on Tamil Nadu government's books will be restructured. The TFC has also recommended debt write-off linked to reduction in the revenue deficit o f the state government. Under the scheme, a certain proportion o f repayment o f rescheduled debt will be written off by Government o f India over the period 2005/06 to 2009/10. The quantum o f write-off i s linked to the absolute amount o f reduction in the revenue deficit each year with the ultimate objective of eliminating the revenue deficit by 2008/09. Tamil Nadu can benefit to the extent o f Rs. 1,718 crore in debt write-off under the scheme. Tamil Nadu also gets Rs. 1,826 crore in special purpose grants over the TFC award period. The TFC's recommendations and a revised MediumTerm Fiscal Policy o f the Tamil Nadu government incorporating the TFC award became available after this report was prepared. This report has been updated with information from these two documents to the extent possible. 7. To provide context, this report begins by reviewing development outcomes and challenges, including the Millennium Development Goals, in Tamil Nadu (Section I). Section I1focuses on fiscal correction and sustainability. Section I11focuses on improving investment climate for promoting private sector development in manufacturing and services. Section IV i s devoted to reinvigorating agriculture growth. Section V addresses challenges o f strengthening public administration and improving service delivery. Section VI discusses the strengthening o f poverty monitoring and evaluation. Section VI1 concludes with a summary o freform challenges and risks. 11 EXECUTIVESUMMARY Tamil Kadu's Development Achievements and C%ailenges Successfir1poverty reduction and development outcomes Tamil Nadu's performance on poverty reductionwas above India's national average inthe 1990s achieving an above-average reductioninpoverty inboth rural and urban areas. Tamil Nadu's poverty headcount has reduced from 35.4% in 1993/94 to 21.1% in 1999/2000 according to Planning Commission's estimates. Notable success has been achieved inhuman development outcomes too inthe state. Frombeing a near-average state with a Human Development Index (HDI) o f 0.343 in 1981, Tamil Naduhas moved to a high-performing state with the thirdhighest HDIo f 0.53 1in2001. Tamil Nadu i s on track to meet most o f the MillenniumDevelopment Goals (MDGs), with trend performance better than required for such important MDGs as poverty reduction, child malnutrition, school enrollment, and infant mortality. Tamil Nadu's success i s the result o f sustained economic growth and an effective human development strategy. The strategy has focused on three main areas: (i) expanding the coverage of social services, (ii) improving the quality o f services provided, and (iii)ensuring wide participation o f the poor and other marginalized groups. Notwithstanding positive development outcomes, Tamil Nadu faces many development challenges. Still a low-income state, Tamil Nadu has a relatively highpoverty incidence, and gender, caste, and intra-state disparities in key poverty and social indicators. High drop-out and low completion rates continue to reduce the effectiveness o f Tamil Nadu's secondary education program. The crude birth rate has been hovering around 19-20, neo-natal mortality has been stagnating, and female infant mortality rate remains high. There are significant rural-urban differentials and inter-district variations. The state also faces a high rate of malnutrition in children, and confronts a high prevalence o f HIV/AIDS. Tuberculosis is reemerging inassociation with HIV/AIDS and non-communicable diseases are on the rise. Growth has slowed down The liberalizationinthe 1990s accelerated economic growth inTamil Nadu. However, inrecent years growth has slowed, from an annual average o f 6.6% from 1990/91 to 1998/99 to an annual average o f about 3.7% from 199.9/00 to 2002/03. Much o f the recent slowdown i s attributed to the impact o f the droughts on agriculture and their spillover to other sectors. Three annual droughts, ledto an annual average o f-3.9% growth during 1999/00-2002/03 compared with an annual average o f 4.5% inthe previous nine years. Although droughts are exogenous shocks, there are structural impediments, overcoming which could put economic growth on a higher trajectory path o f 8% targeted by the GoTN to accelerate the pace o f poverty reduction. Tamil Nadu's agriculture faces challenges o f growing water scarcity, land-degradation, decline infarm sizes, and rising cost o f agncultural labor. Although, Tamil Nadu has been one o f the most favored foreign and domestic investment destinations in India accounting for 15% o f all-India merchandise exports and 17% o f all-India IT exports, the investment climate faces several constraints. Rigid labor regulations, a complex and cascading indirect tax system, protracted exit and bankruptcy procedures, and infrastructure deficiencies are among the key constraints to better manufacturingperformance in India and Tamil Nadu i s not an exception. The World Bank's 2003 investment climate survey o f the manufacturing sector in Tamil Nadu reaffirms this assessment. Higher manufacturing growth, together with the growth o f the service sector, i s critical to absorbing surplus agriculture labor and reducingrural poverty. ... 111 Fiscal Reforms Fiscal crisis tlireatenedprospectsof sustainedpoverty reduction intervention b-v the state The fiscal crisis beginning in 1998/99 and slowdown ineconomic growth since the late 1990s not only seriously threaten the prospect for sustained poverty reduction inthe future but also endanger the gains already made. The most immediate challenge that faced Tamil Naduin 2001/02 was to reverse the rapid fiscal decline and create fiscal space for development spending. With salaries and pension o f government employees (2% o f the state's population)-accounting for government's entire own revenue duringthe crisis there was little fiscal space left for essential infrastructure and social spending. State Government lairnched ambitious reforms targetingfiscal correction and restructuringpublic expenditure Beginningfrom 2001, the government embarked on ambitious reforms over the nexttwo years touching a numbero f areasinbothrevenue and expenditure. The government proceededto do so at arapidpaceto catch up with other reforming states such as Andhra Pradesh and Kamataka. Some o f the reforms were bold and pathbreakingboth inthe context o f the past history o f the state, such as inthe Public Distribution System (PDS) and agriculture power tariff, and inthe national context such as pension reform. The reforms were undertaken, notwithstandinga difficult economic environment posed by successive droughts and low economic growth. Significant gains were made over the next two years and aggressive fiscal reform targets were set for the future. By attempting expenditure reallocationthe program sought to improve growth and human development achievement. Critical elements o f the fiscal reform program included: the development o f a multi-year framework for fiscal adjustment through a Medium Term Fiscal Policy Statement (MTFP); improving legislative oversight and fiscal transparency; restructuring high-cost public debt and management o f guarantees; improving the efficiency o f the tax administration; rationalizinguser charges; introducing a targeted PDS, introducing apcultural power tariff; reforming state-owned manufacturingenterprises and ailing cooperatives; and strengthening public expenditure management and financial accountability to increase the efficiency o fpublic spending. The impact o f the fiscal adjustment programhas beenimpressive. While the revenue (current) deficit declined from 2.1% o f Gross State Domestic Product (GSDP) in2000/01 to 0.9% o f GSDP in2003/04 and 2004/05(RE), the fiscal deficit declined from 4% o f GSDP in2000/01 to 2.4% o f GSDP in2003/04; but increasedto 2.9% in2004/05(RE). The state also achieved aprimary surplus of 0.3% o f GSDP in 2003/04 as compared to a deficit o f-2.5% o f GSDP in 1999/00. A key objective o f fiscal adjustment was cleaning up o f accumulated arrears from prior years. A large amount o f arrears, Rs. 3,062 crore equaling to 2% o f GSDP, was cleared in2002/03, including the securitization o f Rs.1,962 crore o f dues to central electricity utilities by the Tamil NaduElectricity Board. The consolidated fiscal deficit (which consolidates the non-power budget fiscal deficit with the Tamil Nadu Electricity Board's financing requirements) was reduced from a peak o f 6.7% o f GSDP in 1999/00 to 4.8% o f GSDP in2002/03. The close to two percentage point reduction from 1999/00 to 2002/03 was largely attributed to an increase in the ratio o f the state's own tax revenue to GSDP (from 8.6% in 1999/00 to 9.3% in2002/03), and a reduction inthe ratio o f salaries to GSDP (from 6.5% in 1999/00 to 5.2% in2002103). The consolidated fiscal deficit decreased further to about 3.8% o f GSDP in2003/04. The composition o f expenditure has shown improvement with higher allocations for non- wage Operations and maintenance expenditure, particularly in2003/04 and 2004/05(RE). The share o f capital outlay, net lending, non wage operations and maintenance expenditure showed sharp recovery in2003/04 and 2004/05(RE) after declining over the earlier two years. Based on the fiscal turnout in 2004/05(RE) and takmg into account the TwelfthFinance Commission's recommendations, the Government o f Tamil Nadu has tabled a revisedMTFP along with the 2005/06 iv budget. The MTFP revisedalong conservative lines seeks to generate a revenue surplus by 2008109 and bringthe fiscal deficit to below 3% o f GSDPby 2005/06. The MTFP targets are achievable. Gettingthe fullbenefit o fthe Finance Commission's recommendation on debt relief andwrite-off is conditional on the state meeting these revised targets. The Government o f Tamil Naduhas initiatedreforms o fthe systems and processes o fbudget formulation and execution. However, reforms are neededto achieve the Government's development objectives and to adapt the institutional arrangements to support fiscal strategy. The key challenge i s to ensure that a comprehensive resource framework and a medium-term perspective effectively guide the three objectives o fbudget management: aggregate fiscal discipline inline with the medium-term fiscal program, strategic policy decisions by the Government within the constraints o f the fiscal program, and efficient use o f public expenditure ingovernment operations. The Tamil NaduFiscal ResponsibilityAct (FRA), already passed by the government lays the foundation for aggregate fiscal discipline by emphasizing transparency and disclosure o f the medium-termfiscal programwith each budget. But attention will be requiredto comply with FRAprovisions. Tamil Nadu needs to substantially strengthen its upstream capacity for policy formulation. The establishment o f a Policy Review Committee, to be chaired by the Development Commissioner, could provide leadership and focus to this key capacity-enhancing reform. The Policy Review Committee can rely on a network of public and private institutions to undertake public policy research and analysis. An early submission ofthe draft budget to the legislature canhelpbringbudgetapproval closer to the start o f the fiscal year, facilitating budget execution. A review o fbudget execution processes can help identify and address current weaknesses. Together with improvements ininternalcontrol systems, the Government should explore an increase the scope for virement within departmental budgets. The Government should also plan to constitute a standing ExpenditureReview Committee to undertake rolling annual reviews o f departments to identify unproductiveprograms and to rationalize and improve efficiency o f existing programs. The framework for public financial accountability inTamil Nadu i s generally sound. Nevertheless, several areas need strengthening. The need for reformi s particularly evident inthe area o f budget execution procedures, including the weaknesses ininternal controls and the need to eliminate or reduce reliance on PersonalDeposit Accounts inthe Public Accounts. The Government also needs to develop measures to address key internal control issues such as reconciliation o f accounts, reconciliation o f loans and advances, timely submission o f utilization certificates, and incentives for compliance. Policy reversals after national elections of 2004 impede acceleratedprogress infiscal restructuring Followingthe national elections inApril-May 2004, inthe state, key policy reforms were rolled back. A series o f quick reversal o f significant reformmeasures was announced (power, PDS and reintroduction o f free buspasses for students and withdrawal o f other minor user charges). This has posed increased expenditure besides making it more difficult inthe future to return to the policyreform path. Extension o f free power to all agriculturists and slashing power tariff to domestic consumers to pre-reform levels o f 2001 i s expected to cost Rs. 920 crore in2004/05, withdrawal o f PDS targeting will raise food subsidy by about Rs. 130 crore in2004/05 and restoration o f student bus passes & concession fare would cost Rs. 125 crore in2004105. Additional expenditure on account o fthese proposals in2004/05(RE) i s about Rs. 1,650 crore. The impact o f these i s seen inthe 2004/05(RE) wherein despite higher revenue outturn and large savings insalary andpension expenditure (as compared to the budget), the fiscal deficit increased to 2.9% o f GSDP as compared to 2.4% in2003104. If fiscalreformandMTFParebroadlyontrack,TamilNadu'sdebtstockisexpectedtostabilize the around 31% o f GSDP (from 28% in 2003/04), a level below that inmany other Indian states. However, V due to fiscal burden o frecent policy reversals, the debt to GSDPratio may increase to 32% of GSDP by 2008/09. Improving the lnvestmcnt Climate Complementaryfocus on improving the investment climate requiredfor accelerating growth Fiscalreformmust be complemented with a strong program to improve the investmentclimate for accelerating economic growth and poverty reduction. Findingsfrom the investment climate surveys in Tamil Nadu suggest that cumbersome and excessive regulationand infrastructure bottlenecks are major or serious constraints to growth. Recognizingthe role o f the private sector as an engine o f economic growth, the Government o f Tamil Naduhas put emphasis on streamlining complex government. regulations over private investment and production, and on strong partnership with the private sector for sustainable infrastructure financing and development. A number o f infrastructure projects executed inthe Public Private Partnership (PPP) format bear testimony to government's commitment. The reform agenda before the government deals with not only regulatorypolicies and practices concerning all factor markets (labor, land, and capital), but also regulation o f entry/exit for enterprises and tax policy and administration. There are 23 Union Acts and seven State Acts andRules which are enforced by the Labor Department inTamil Nadu. For each o fthese subjects there are different enactments by the center as well as implementingrules by the state. Many regulations are excessive and outdated (e.g., no overlapping o f shifts, capping o f overtime, official permission required for working on Sunday or holidays, specified number o f food cafeterias, and over 60 types o f minimumwages). Labor regulations are largely within the purview o f the central government. Nonetheless, within the federal framework, Tamil Nadu can explore ways to rationalize and consolidate implementing rules concerning the legal framework governing labor and statutory compliancerequirementsto create elbow roomfor contractual labor relationshipand for easing threshold for retrenchment. Urban land market suffers from systemic weaknesses Tamil Nadu's urban land market suffers from systemic weaknesses. Master plan designations inthe absence o f complementary incentives and measures make the supply o f land for development inefficient. Urban land issues are within the purview o f the state government. It i s important to rationalize regulations on urban land zoning and development controls, and project approval and land acquisition processes, and develop a more effective planning and management system to facilitate infrastructure development. Tax administration imposes high compliance costs The tax administration imposes highcompliance costs by, for example, lack o f self-assessment inthe sales taxation for large businesses and o f electronic filing, cumbersome registrationprocedures, and time- consuming dispute resolution, which all encourage undesirable frequent contacts between businessmen and tax officials. Some o f these and tax issues will be resolvedwhen VAT i s implemented. Streamlining Business Entry Tamil Naduhas made progress in simplifyingregulations over business entry. The sequential and protracted approval process involvingmultiplegovernment departmentdagencies has beenreplaced by a streamlined and coordinated one for large investment projects. The streamlined process for large investment projects needs to be extended to all small and medium-sized and small projects. Infrastructure a constraint to improving competitiveness Power has become a major infrastructure constraint despite the relative efficiency o f the state power utilityandhavingthe second largest power market inIndia. Highpower tariffto industries andpoor quantity and quality o fpower supply reduce the competitiveness o fTamil Nadu's industries. The financial stress o fthe TNEB, arising largely from cross subsidy to agnculture (and now the domestic vi consumer segment also), has increasingly constrained its investment ability to improve the quality o f power supply. Like many other states, Tamil Nadu will need to find a political solutionto the metering o f agriculture pump sets and reduction o f cross-subsidy to improve the competitiveness o f industryand services. A clear regulatory framework for support ofpublic privatepartnerships ininfrastructureneeds to be put in place which would define the role o f the government and the private sector, lay out the risk sharing principles and also regulate the tariffregime for private roads. An importantpriority i s to press forward with fiscal reformto create fiscal space for investment inthe infrastructure sector. Priority Reforms Priority reforms comprise the following areas: labor market flexibility; a more responsive urban land supply system; more efficient tax policy and administration; continuingreformto ease entry and operation; power sector reform; and scaling up PPP for sustainable infrastructure development. Some o f which are not entirely inthe state's purview, but which the state can articulate inits dialogue with the central government. The wide scope o fissues i s not surprising and will thusrequire an institutionalized dialogue between the Government and the private sector for setting priorities and finding solutions. Agriculture Traditional sources of agricultural growthface major constraints While agncultural sector growth rates inTamil Naduwere among the highest inIndia duringthe 1980s and early 1990s, deceleration ingrowth since the mid-1990s i s o f increasing concern to policymakers. Duringthe 1980s agricultural GSDP grew at 3.4 percent, exceeding the all-India agriculturalgrowth of 2.9 percent. Butrepeated drought inthe nineties meant that the state's agncultural growth rate was only 2.9 percent a year, compared with 3.2 percent for the nation. Analysis has shown that a one percent increase inrainfall relative to the mean i s associated with a 0.3 percent increase inreal agricultural GDP relative to the trend agricultural GDP. There are three salient features o f Tamil Nadu's agriculture that set the political economy context for searching a viable strategy for revitalizing agriculture growth: water scarcity; the large share o frice and sugar cane (both water-intensive crops) intotal irrigated land; and the dominance o f small and marginal farmers inoverall agriculture production. Faster growth in agriculture i s central to rural development and poverty reduction inTamil Nadu. Although agriculture accounts for only 14% o f Tamil Nadu's GSDP and non farm income accounts for about 50% o frural household income, farm income accounts for about halfo f household income for 35 million people (56 percent o f the state's population) who live inrural areas. Traditional sources o f agncultural growth, however, face major constraints including growing water scarcity, increasing land degradation and declining farm sizes, and risingcosts o f agricultural labor. The agricultural sector faces increasing competition for water from industry and domestic users and intensifyinginterstate competition for surface water resources. Inmany parts o f the state, the rate o f extractiono f groundwater has exceeded recharge rates, contributing to falling water tables. Efficient water resource management i s a key priority for not only agriculture but also the entire state economy requiring complex regulatory and institutional changes beyond the medium term. Crop Diversijkation importantfor future agricultural growth Given water scarcity, diversification into less-water intensive higher-value products i s the most promising avenue for future agricultural growth. Broader institutional and policy reforms are required to efficiently manage scarce water resources, decentralize the agricultural extension system, improve rural infrastructure to facilitate efficient markets, and reorient public expenditure towards growth-enhancing areas such as rural roads, markets and agncultural research. vii Marginal Costpricing of water arid electricity will rationalize water use Gradual steps towards marginal cost pricing o f water and electricity, (perhaps combined with compensation to farmers inthe form o f income transfers or more reliable electricity supply), would help rationalize water use inTamil Nadu. The agnculturalpower tariff introduced inMarch 2003 included a flat rate for unmetered connections o f Rs.250 per horsepower a year and Rs.0.20 per kilowatt-hour for metered connections. Along with the reintroduction o fagricultural power tariff, the government announced an income support scheme for smallholders and marginal farmers. Under the income support scheme, the Government o f Tamil Naduprovided smallholders and marginal farmers a transfer o f up to Rs. 1,250 ayear. This was a significant step toward creating amore direct and transparent system of subsidies to farmers and other target groups and ensuring the separation o f commercial operation o f the power utility from the need for subsidy. However, these initiativeswere rolledback after the national elections in2004. Metering o f farmers i s critical to link agricultural tariffs to consumption levels. Metering will also enable power subsidy to be better targeted. Iffarmers costs and incomes varied according to the amount o f electricity (and water) used with well irrigation, farmers would have an incentive to shift some land from water-intensive crops towards less water-intensive crops. Greater attention to marketing infrastructure, strengthening the researchand extension system to meet the needs o f diversified agriculture, the development o f tools for farmers to better manage risks, improving irrigation pump set efficiency and puttinginplace safety net programto cushion against the risk o f diversificationparticularly for small and marginal farmers who rely mainly on agnculture subsistence income may create an environment within which higher power charges would be more palatable for farmers. Governance and Service Delivery Thegovernment's capacity to deliver services needs strengthening The strengthening o fpublic expenditure management and financial accountability would needto be supported by public administration reformto enhance service delivery. Tamil Naduhas done well in delivering key services: A recent survey conducted by the Public Affairs Center reveals that the state has the country's best public distribution and school education systems, and the second best public drinking water androad transport services after Gujarat. This, o f course, i s not a uniformpicture: health services, for example, are ranked fifth. Tamil Nadu faces several critical challenges that need to be addressed to preserve and extend the gains made so far. To support fiscal reform and the reformo f the investment climate, service delivery reform would also need to focus on strengthening the effectiveness o f the government by rationalizing its role and responsibilities, simplifying decision-malung processes, improving the stability o f staff tenure, and enhancing critical services delivery-which have a large public interface through a combination o f measures such as agency reform, e-governance, and public private partnerships. Further, the reform would need to address the transparency issues regardinggovernment and corruption, through a major overhaul o f the public procurement system, enacting new "Right to Information" legislation, and strengthening the anti-corruption machinery. Improving CivilServiceproductivity is key to efflcierit government The civil service inTamil Naduhas proliferatedinthe last twenty years: Tamil Nadutoday possessesthe highest ratio o f civil servants per hundredpopulation inIndia o f any major state after Punjab. To rationalize and restructure the civil service and improve its productivity, the Government constituted a Staff and Expenditure Reforms Commission (SERC) inDecember 2001 to systemically review and realign the roles and responsibilities o f each o f the 140 departments and identify redundant departments/functions/posts,including areas where the government should exit and let the private sector take over. The exercise was carried out with the benefit o f extensive consultation within the government, including with staff associations and unions, as well as consultation with the public. The SERC reports viii have identifiedabout 85,000 surplusposts, and 113,000 vacant posts made feasible by hiringfreeze. The reductioninthe core civil service size (posts) by 2007/08 (from 2002/03) can be achievedby abolishing 85,000 posts using2002103 as the baseyear. The abolishing o fthe surplusposts will enable a more efficient allocation o f staff across departments within the targeted ceiling. To simplifythe decision-making process, the SERC also reviewedthe functioning o f the Secretariat, focusing on improving efficiency through delegation to heads o f departments, level-jumping, the introduction o f the single-file system, and computerized file monitoring and greater flexibility for redeploying staff. The government has issued orders permittingleveljumpingo f files. Responding to the problem o f pre-mature transfers, the Government introduceda systemo f formal counseling for transfers inboth the Healthand Education Departments. The Government has also issued orders regardingnorms to be followed intransfers covering the entire civil service. The order specifies transferring authorities, established norms for three- to seven-year tenure, limited transfers to 20% o f cadre strength and to the season only, and announced the creation o f a public transfer database on the internet to track transfers over time. Roomfor improving Service Delivery While Tamil Nadu has done well in service delivery insome key areas relative to the rest o f the country, there i s still room for improvement. A number o freforms are ongoing; these include improving the Registration Department by introducing a computerized guidance value calculation software package for use inits sub-registries, and promoting the development o f luosks invillages to improve rural service delivery and empower rural citizens. Over the next few years, inaddition to policy and institutionalreforms ificritical sectors such as water supply and sanitation, education andhealthto enhance service delivery, the Government plans to focus on improving 10 critical services with a largepublic interface, including regional transport services, commercial tax, stamps and registration for property transfers, district administration, and local bodies. It plans to accomplish this through a combination o f measures such as e-governance, process reengineering, citizens' charters, and partnerships with the private sector. Revision o f citizen charters for agencies with large public interface mustbe done on a priority basis (e.g. district hospitals) and surveys usedto provide feedback. Systemic reforms required to improve Transparency Tamil Naduwas the first Indian state to introduce legislation, in October 1998, to improve transparency in public procurement and to regulate tendering and contracting procedures o f government departments, statutory bodies, public sector enterprises and other local bodies. The pace o fprocurement reformhas been accelerated, focusing on the implementation o f the Act. The government has completed a three-year comprehensive procurement reformactionplan. This will include: setting up a complaint/challenge/appeal mechanism; finalizing and issuingfive sets o f Standard BiddingDocuments; finalizing the revision o f Finance, Accounts, and Public Works codes; improving works procurement procedures; introducing code o f ethics for officials and the business community and tightening enforcement; evaluation o freservation and exemptions with a view to provide a level-playing field; enlarging the scope o frules to cover consultant selection procedures; and issuing guidelines and directives on procedural improvements. Inadditionto ongoing systemic reformsto prevent corruption(e.g., procurement reform, business deregulation, e-governance, and fiscal transparency), enforcement efforts need strengthening. The Vigilance Commission and its investigating agency, the Department o fVigilance and Anti-Conuption (DVAC) function as government agencies. Neither the Vigilance Commissionnor the D V A C possessed a public website to disseminate performance information. The government needs to consider the creation ix o f an independent institutionalmechanism to focus on corruption and grievance redressal inservice delivery, and greater transparency inthe functioning o fDVAC. Tamil Nadupassed the country's first Right to Information (RTI) Act in 1997; the Act itself, however, was flawed with numerous exemptions. The law falls below GoI's standards set inthe Freedom o f Information Act (2002), as well as the standards o f state laws inDelhi,Karnataka, and Maharashtra. The Government i s currently preparing a new draft law that will provide for minimal exceptions, an independent appeals process, penalties for non-compliance, and more automatic disclosure o f information by departments. Poverty and HumanDevelopment Tlie capacity to monitor theprogress of poverty and human development remains critical About 12million people live inpoverty inTamil Nadu. Scheduled castes and tribes are highly representedamong the poor due inpart to their owning less land, and o f lower quality, as well as other assets (particularly human capital). Important challenges inthe non-income dimensions o fpoverty remain to be tackled inhealth, education, water supply and sanitation and nutrition. The broad structural reform program thus needs to be supported by protectingthe poor and vulnerable through targeted interventions. The Tenth Five-Year Planprovides a detailed description o f the poverty- reduction programs, which are wide ranging, to cover health, education, water supply and sanitation, and food security. These programs include schemes targeted to particular social and demographic groups such as scheduled castes and tribes, women and children. The specific interventions broadly match the spatial and social needs revealedby the poverty diagnostics although there i s scope for improving the design and targeting efficiency. To this end, strengthening poverty monitoring and evaluation for effective targeting i s an important focus area. For example, developing strong institutional capacity for evaluation based learningi s invaluable for improving the targeting inschemes such as the Public Distribution System. Similarly, buildinginstitutional capacity for an effective monitoring and feedback mechanism that ensures aligning o fbudgets to priority needs ineducation, health and broader aspects o f service delivery will be important inthe coming years. There appears to be a case for paying special attention to the rural areas inthe Coastal North and the South, and possibly to the urban areas inthe Coastal North. Scheduled Castes and Scheduled Tribes also appear to face particularbarriers to upward mobility, and the data suggest that these stem at least inpart from three sources: access to land, education, and regular non-farm employment. Addressing them will therefore be a vital part o f any poverty alleviation strategy pursued by the state. Investment inpoverty monitoring and evaluation importantfor developing a coniprelzeizsivepoverly reduction strategy Developing a comprehensive poverty reduction strategy will involve more investment inpoverty monitoring and evaluation (M&E). This i s not a problem particular to Tamil Nadu: it i s common to all o f the states inIndia, as it i s to most o f the developingworld. Monitoring o f extant anti-poverty policies and social services more generally is, however, important ifone i s to gauge whether implementationi s proceeding according to plan and achieving its stated objectives. The Government o f Tamil Nadui s an ideal agent for engaging inM&E, given its voluble commitment to combating poverty, openness to receiving feedback, andrichhuman capital resources. Impact evaluations are most appropriate to programs which are innovative, replicable, involve substantial resource allocations, and have well-defined interventions. The capacity to monitor the progress o fpoverty and human development and linkthat with overall policy and poverty-reductioninterventions remains critical. There i s also scope for aligning the various X programs listedinthe Tenth Planto improve coordination and targeting: many programs are not coordinated, with multiple, overlapping and sometimes different objectives. Capacity to manage a complex and growing reform agenda reqirires strengthening. Substantial capacity buildingand broad-basedknowledge partnerships can help address the management of reforms inpriority areas such as water resources management, agriculture diversification, public expenditure management, and public-privatepartnerships ininfrastructure financing and development. In summary, much has been achieved but a lot remains to be done. Political economy and capacity constraints may result intemporary reformuncertainty. What i s critical i s commitment to reform, as well as the sequencing and prioritization o f reforms, and careful managing o f trade-offs inreform gains, costs, and risks. To do so, it i s important to build a broadly-shared consensus through public debate and to carefully design a minimumset of policies and programs to compensate for the impact o f reform, so as to maintain a critical mass o f support for reforms to proceed. xi I. DEVELOPhlENTOUTCOMESANDCHALLENGES DevelopmentOutcomes 1. Millennium Development Goals (MDGs). A graphical analysis o f Tamil Nadu's performance against six o f the MDGs i s presented below (Figurel.1). Tamil Nadu i s on track to meet most o f the MDGs,with trend perfonnance better than requiredfor such important MDGsas poverty reduction, child malnutrition, school enrollment, and infant mortality. Reduction in the discrepancy o f male-to-female literacy i s slightlybelow the target. Figure 1.1: ProgressinTamilNadutowardKey MillenniumDevelopment Goals (MDGs) i 1. Poverty Reduction I 2. sild Malnutrition (c5years) 3 . School Enrollment:B-IO Year-Olds 4. Ratio of Female toMale Literacy i I 1 .12- I r lffi 1994 20 01 20 15 1987 19% BO1 2008 2015 Year Year 5. Infant Mortality Rate 6.Access to Safe Water _--- 100p 1987 1994 2031 2m8 2015 1 --o--- MDG target -Tamil Nadu -Actual 1 Note: The baseline for the MDGs i s based on extrapolation from existing data to the MDGbaseline year, 1990. 2. Poverty outcome. Tamil Nadu's performance on poverty reduction was above India's average in the 1990s (Figure 1.2), according to the Deaton and Dreze estimates (2002). Rural poverty in Tamil Nadu fell from 38.5% in 1993/94 to 24.3% in 1999/2000, compared with an all-India decline from 33% to 26.3% (Table 1.1). Rural poverty varied widely across regions in 1993/94. As rural poverty has fallen, the sharp regionalvariationhas also attenuated. Ruralpoverty is the highest inthe coastal north. Poverty rates in urban areas also tend to be lower than those in rural areas. Urban poverty fell from 20.8% in 1993194to 11.3% in 1999/2000, compared with an all-India decline from 17.8% to 12%. Thus, compared with the all-India performance, Tamil Nadu achieved an above-average reductioninboth rural and urban areas. Tamil Nadu ranks sixth out o fthe 15 major states inper capita income. Figure 1.2: Tamil Nadu's performance on economic growth and poverty reduction Growth rate of per capita income during the 1990's Declinein Poverty Ratebetwen 1993194-1999100 KN GJ HY I 64% TN PJ I60% WE KR 145% 2y-n I ' MH 4 6% I GJ. 14% KR 4.6% 1 4- India 4.2% I A P 4 "YO I RJ j 3.5% I M P -^"I -0 7% Note: AP: Andhra Pradesh, BH: Bihar, GJ: Gujarat, HY: Haryana, KN: Kamataka, KR: Kerala, MH:Maharashtra, MP: Madhya Pradesh, OR: Orissa, PJ: Punjab, RJ: Rajasthan, TN: Tamil Nadu, Up: Uttar Pradesh, &WB: West Bengal. Angus Deaton and Jean Dreze (2002), "Poverty and Inequality inIndia: A Reexamination," Economic and Political Weekly, September 7. Source: CSO, NSSO, Planning Commission, Census o f India Table 1.1: State-Specific Poverty Headcount Ratios in the 1990s(YO) Keduction Reduction from Reduction from from 1999100 1993194 1999100 1993194 1999100 1993194 3. It is important to note that poverty estimates in India based on the 55th round National Sample Survey Organization (NSSO) Consumer Expenditure Survey have been the subject of much analysis and debate. Depending on the specific model used to adjust for comparability between the NSSO rounds o f 1993-94 and 1999-2000, there are different estimates on the extent o f poverty reduction between these two years. The Government o f India's estimate shows that Tamil Nadu's poverty headcount was reduced from 35.4% in 1993/94 to 21.1% in 1999/2000. An alternative estimate based on a model postulating a relationship between poverty and household characteristics (Kijima and Lanjouw, 2003, a Bank policy research working paper) shows poverty declined from 30.3% in 1993/94 to 28.9% in 1999/00. These different models also induce variations inthe rural and urban headcount rates. A resolution o f this debate i s not possible for now, since there i s no scientific way o f determining which o f these models better reflect the "true" picture - being essentially ex post methods o f adjusting consumption expenditures to achieve comparability between the two surveys, usingalternate sets o f assumptions that cannot be tested. 2 However, no matter which precise method i s used, Tamil Naduhas made progress inpoverty reduction in the latter half o fthe 1990s. 4. Education and health outcomes. Tamil Nadu has achieved notable success inhuman development outcomes. It has moved from being a near-average to a high-performing state, as indicatedby the Human Development Index (HDI) measured in terms o f longevity, education and command over resources. In 1981, its HDI ranked seventh, at 0.343, only slightly above the national average o f 0.302. By 2001, however, Tamil Nadu's HDIrose to the thirdhighest, at 0.531, higher than the national average o f 0.472.' Tamil Nadu has been a pioneer in India in integrating nutrition and increasing enrollment o f children in elementary education. Education and health outcomes in the state have also improved across gender, caste, income and regional dimensions, particularly in the access to primary-level health and education services. The well-known Noon Meal Scheme (NMS), which started in 1982, covers all children ages 2- 15 in both rural and urban areas. The main objective o f the N M S was to ensure nutritional support to children but also to act as an effective incentive for achieving universal education. The program has been emulated by other states and has recently been viewed by the Go1as a model. 5. Tamil Nadu's success i s the result o f sustained economic growth and an effective human development (HD) strategy. This strategy has focused on three main areas: (i) expanding the coverage o f social services, (ii) improving quality o f the services provided, and (iii) ensuringwide participation o f the poor and other marginalized groups. A political consensus for investingin human capital by successive state govemments' and the use o f a multi-sectoral approach to addressing human capital formation has also contributedto human capital gains. 6. Gender equity. Thirty-three percent o f seats are reserved for women in all statutory and non- statutory committees o f the state government. Tamil Nadu's performance with respect to female literacy, female infant mortality rate, female life expectancy and fertility rates shows that the status o f women in Tamil Nadu i s higher than inmost Indian states. The Gender Development Index (GDI) for Tamil Nadu i s 0.654 (2001), as against the all-India average o f 0.560. Socio-economic empowerment o f women through the provision o f opportunities for education, self-employment and training are priorities. A key initiative i s the Tamil Nadu Women's Development Project (Mahalir Thittam); the project supports over 187,000 Self-Help Groups, with membershipo f 3.1 million and savings o f about Rs.6 billion. Moreover, owing to assistance in establishing credit linkages with financial institutions, the Self-Help Groups have been able to access credit assistance amounting to Rs.10 billion. 7. Economic growth. The liberalization in the 1990s accelerated economic growth in Tamil Nadu, increasing average real GSDP growth rates to 6.4% from 5.4% in the 1980s. Tamil Nadu's per capita income growth ranked the third highest among Indian states in the 1990s. The faster growth o f industry and services relative to agriculture has changed the shares o f these sectors inthe GSDP (Figures 1.3 and 1.4). Tamil Nadu has been one o f the most favored foreign and domestic investment destinations in India; but India as a whole has lagged behind some other countries. Tamil Nadu accounts for 60% o f merchandise exports o f four southern states, 15% o f all-India merchandise exports and 17% o f all-India IT exports; in 2001102, it exported US$6.5 billion worth o f merchandise and US$1.2 billion worth o f IT services. IT has been Tamil Nadu's strongest growth sector since 1997/98, growing by nearly 40% on an annual average basis. Traditional exports, such as textiles, ready-made garments and leather goods, have grown by only 3-6% on an annual average basis over the same period. 8. Economic growth has slowed since the late 1990s. The slowing i s mainly the result o f a decline in agriculture largely on account of three statewide droughts and their spillover impact on other sectors (see para. 17 for analysis). National HumanDevelopment Report, 2001, PlanningCommission, Government of India. 3 Table 1.2: RuralPoverty Incidenceand Shares by Land Ownership among SC/ST's NSSO Round sotb 551b % o f rural % o f rural Extreme Poverty SCiST % share o f % share Extreme Poverty SCiST % share of % share Poverty Incidence population extreme of the Poverty incidence population extreme of the Incidence poor poor incidence poor poor No land 24 47 27 23 24 21 40 17 11 12 >O & ?0.4 ha 31 57 57 62 61 32 58 71 71 73 >0.4 & ? 1 ha 33 56 10 12 11 53 74 8 13 10 >1 & ? 2 ha 21 45 4 3 3 40 70 3 4 4 > 2 & ? 4 h a 0 11 2 0 0 17 50 1 0 1 >4 ha 0 0 0 0 0 0 1 0 0 0 overall 28 53 100 100 100 32 57 100 100 100 Note: (1) Extremepoverty i s defined as per capita consumptionrank <20% in the total consumptiondistribution.(ii) Povertyis defined as per capita consumptionrank <40% inthe total consumption distribution. 11. Rural poverty i s concentrated among those with marginal landholdings and dependent on rain-fed agriculture. As one moves from the lowest- to the highest-income quintiles o f rural household income, the contribution o f agricultural wage income to total income decreases monotonically, while that o f cultivation and non-farm sources increases monotonically (Table 1.3). Reinvigorating agriculture growth and accelerating industrial growth, together with solid growth in the tertiary sector, remain critical for sustained poverty reduction. Data limitation prevents a fuller understanding of urbanpoverty. Quintile Cultivation Agriculture Nonfarm Non farm Self Non farm Total Non Other RealPer wage Labor wage Labor employment Regular farm sources Capita Employment sources IncomeRs. 12. Important challenges in the non-income dimensions o f poverty remain. High drop-out and low completion rates continue to reduce the effectiveness o f Tamil Nadu's secondary education program. Completion and drop-out rates still mask disparities across the state (Figure1.6). For example, about 15 percent o f students drop out at the primary level, nearly a third by elementary school, nearly three-fifths prior to completing Grade X (or SSLC) and about three-fourths by Higher Secondary. There are still gender, caste, inter-distnct, and urban-rural disparities. The gender gap in education i s especially larger among poorer households. Scheduled castes and scheduled tribes also have significantly lower educational attainment than non-scheduled casteshcheduled tribes. 5 I h 15. The increasing reliance on borrowing to finance growing 40.0% 1 Figure19 : DebtandGuarantees recurrent expenditure steadily increased the state's debt burden. The debt-to-GSDP ratio climbed from 16.2 percent in 1997198 to 28 percent in 2002/03. The ratio o f debt to revenue receipt increased from 125 percent in 1997198 to 212 percent in 2002103. Debt accumulation resulted in rapid increase in interest expenditure. Furthermore, guarantees as a percent o f GSDP rose to support the market borrowing o f public enterprises. Adding guarantees to explicit public debt, the maximum liabilities o f the Government as a percent o f GSDP increased from 21.4 percent in 0Debt IGuarantees 1997198 to about 34 percent in 2002103 (Figure 1.9). Source : GoTN's Budget Documents 16. The rapid fiscal deterioration i s attributed mainly to: (i) growth of expenditures on salaries, rapid retirement benefits, and pensions, following the implementationo f the Sixth State Pay Commission award along the lines o f the Central Fifth Pay Commission's award (the previous state Government implemented, in 1998, the award with retroactive effect to 1996); (ii)a growing burden of subsidies (particularly food subsidy); (iii)a further decline in Tamil Nadu's share in central tax devolution following the Eleventh Finance Commission's award; (iv) a growing debt and interest burden arising largely from increased borrowing to support the growing revenue deficit; and (v) higher contingent liabilities associated with fiscal support to the public sector units, cooperatives, and the statutory boards. It must be recognized that these systemic factors were undercurrent even before the crisis, and the implementation o f the Sixth State Pay Commission's recommendations triggered the fiscal risks. The fiscal crisis has been a factor in the state's ability to respond to recent growth slowdown and real growth incapital outlay hasbeennegative inthe periodsince 2000/01. 17. Challenges o f accelerating economic growth. Growth slowed from an annual average o f 6.6% from 1990/91 to 1998/99 to an annual average o f about 3.7% from 1999100 to 2002103. Much of the recent slowdown i s attnbuted to the impact o f the droughts on agnculture and their spillover to other sectors. Tamil Nadu's agnculture i s vulnerable to periodic droughts due to its dependency on rainfall. More frequent than in the recent past, three annual droughts including the century's worst statewide drought in 2002, led to an annual average o f -3.9% growth during 1999/00-2002103 compared with an annual average o f 4.5% in the previous nine years. Despite vulnerability to droughts, Tamil Nadu's agriculture has done better than the Indian average in growth and productivity in the past two decade^.^ The weak performance in the agriculture sector has spilled over to the service and manufacturing sectors whose growth has also recently slowed down. In 1998-99,Tamil Naduhadthehighestrice, sugar cane andgroundnutyields inIndiaand cotton yields inthe state were secondonly to Gujarat. Increases inyields enabled landproductivity to grow by 6.1 percent per year between 1987188and 1993/94 fromRs 16,423iha to Rs 23,459ha (in constant 93/94 Rs), but by only 2.4 percent per year between 1993/94 and 1999/00 (to Rs 27,099iha inconstant 93/94 Rs). Likewise, average labor productivity inagriculture increasedby an average of 4.6 percentper year between 1987188 and 1993194from Rs 6,881 per worker to Rs 9,024 per worker (in constant 93194 Rs), but by only 2.4 percentper year between 1993194and 1999100 to Rs 10,434 per worker (in constant 93/94 Rs). 7 18. Although droughts are exogenous shocks, there are structural impediments, overcoming which could put economic growth on a higher trajectory path o f 8% targeted by the GoTNto accelerate the pace o f poverty reduction. Tamil Nadu's agriculture faces challenges o f growing water scarcity, land - degradation, decline in farm sizes, and rising cost o f agricultural labor. &gid labor regulations, a complex and cascading indirect tax system, protracted exit and bankruptcy procedures, and infrastructure deficiencies are among the key constraints to better manufacturing performance in India.4 The 2003 investment climate survey o f the manufacturing sector in Tamil Nadu reaffirms this assessment.' Although manufacturing i s recovering in India and in Tamil Nadu,6 higher and sustained manufacturing growth requires second-generation reforms to improve the investment climate. 19. Higher manufacturing growth, together with the growth o f the service sector, i s critical to absorbing surplus agriculture labor and reducing rural poverty. The primary sector accounts for 50% o f total employment, industry accounts for 24%, and the tertiary sector accounts for 26%. Tamil Nadu has had higher rural non-farm employment than other Indian states (Table 1.4), and industrial activities are more spread across the state than most Indian states. Non-farm activities-manufacturing and services- account for about 50% o f rural household income (Table 1.3). Faster expansion o f the manufacturing and service sectors would help reduce the impact o f seasonality o f rural employment, with acute vulnerability duringthe droughts, onrural incomes. % o f Economically Tamil Andhra Kamataka Kerala All-India Active with Primary Nadu Pradesh Employment in: labor Source: NCAER HumanDevelopment Survey 199314 ReformAgenda 20. Achieving fiscal correction and stabilization. The most immediate challenge that faced Tamil Nadu in 2001/02 was to reverse the rapid fiscal decline and create fiscal space for development spending. With salaries and pension o f govemment employees (accounting for 2% o f the state's population)- accounting for government's entire own revenue during the crisis, or salaries, pension, interest, and subsidies accounting for 94% of the state's total revenue, there was little fiscal space left for essential infrastructure and social spending. In fact, about 70% o f the net borrowing o f the state govemment in The World Bank and the Confederation of Indian Industries, 2002, "Competitiveness of Indian ManufacturingResults from a Firm-Level Survey." The World Bankandthe Confederationo f IndianIndustries, Second Indian States' Investment Climate Survey, 2003. The increase in new investment commitments in manufacturing from April 2001 to April 2003 was highest in Tamil Nadu comparedwith othermajor Indian states, basedon datafromthe Center for Monitoring of IndianEconomy. 8 1999/00 was for debt repayment. The resultant liquidity crisis, ledto accumulation o f arrears that reached 1.7% o f GSDP in2000101 and 2% o f GSDP in2001/02. 21. The then newly elected Govemment tabled a White Paper inthe state legislature inAugust 2001. It analyzed the systemic causes of the fiscal deterioration, and served as a platform to launch a fiscal reform program. To quote the White Paper, "Without a firm commitment to fiscal discipline and prudent management o f State finances, no Government can fulfill the mandate to it by the people." 22. Over the next two years, the government ambitiously embarked on reforms touching a number o f areas in both revenue and expenditure. It proceeded to do so at a rapid pace to catch up with other reforming states such as its neighbors Andhra Pradesh and Karnataka. Some o f the reforms were bold and pathbreakmg both inthe context o f the past history o f the state, such as the Public Distribution System or agriculture power tariff, and in the national context such as pension reforms. The reforms were undertaken, notwithstanding a difficult economic environment posed by successive droughts and the low economic growth. Significant gains were made over the next two years and aggressive fiscal reform targets were set for the future. These would have enabled improvement inspending efficiency by making fundamental changes to the way the budget was prepared and executed. By attempting expenditure reallocationthe program sought to improve growth and human development achievement. 23. But negative electoral results in the national elections in April-May 2004, in the state, brought about a number o f policy changes involving significant rollback o f key policy reforms. What followed was a series o f quick reversal o f significant reform measures (power, PDS and reintroduction o f free bus passes for students and other user charges), adding increased fiscal cost to the budget making it more difficult in the future to retum to the policy reform path. The fiscal reform effort suffered a setback jeopardizing the realization o f the projectedmedium-term fiscal adjustment and expenditure restructuring inthe Medium-TermFiscalProgram. 24. Critical elements o f the fiscal reform program included: the development o f a multi-year framework for fiscal adjustment; improving legislative oversight and fiscal transparency; restructuring high-cost public debt and management o f guarantees; improving the efficiency and equity o f the tax administration and rationalizing user charges; reorienting expenditure from current consumption to growth-enhancing and poverty-reducing investment; reforming state-owned manufacturing enterprises and ailing cooperatives; and strengthening public expenditure management and financial accountability to increase the efficiency o fpublic spending. 25. The most challenging part o f the fiscal reform program continues to remain restructuring spending on salary and pension and on explicit and implicit subsidies. The challenge i s compounded by the constraint on increasing revenue resources. 26. Improving investment climate for manufacturing and services. Recognizing the role o f the private sector as an engine o f economic growth, the Government has put emphasis on streamlining complex government regulations over private investment and production, and on strong partnership with the private sector for sustainable infrastructure financing and development. Tamil Nadu i s at the forefront o f such partnership with a number o f pilots that are the first in India (Box 1.1). The critical role o f the private sector i s facilitated by increasing recognition o f the positive role o f the private sector in infrastructure development; it i s also necessitated by the fiscal crisis and the large backlog in infrastructure investment and maintenance. 9 Box 1.1: PublicPrivatePartnershipinInfrastructureService Delivery e The Tirupur Water Supply Scheme, thefirst water sector relatedproject developed under the PPP framework in India. After a gestation period of almost 10 years, GoTN accelerated and completed legal, financial and management agreements between July 2001 and March 2003. The construction i s on schedule. A total of Rs.45 crore equity and subordinated debt financing from GoTNhas leveraged additional equity financing of Rs.217 crore and leveraged a debt of Rs.700 crore including financing from Tirupur Exporters Association and foreign investors. The project will supply water to the fast-growing garment export industry in Tirupur, domestic consumers in Tirupur Municipality and surrounding villages, as well as a sewerage system for the Tirupur Municipality and onsite sanitation facilities for slums. User charges are based on cost recovery with cross subsidies between industrial and domestic consumers. e The Alandur sewerage project is thefirst such project in India using a PPPframework (BOTformat) toprovide underground sewerage to a town of 125,000 people near Chennai. Public awareness and support was sought through an extensive communication campaign. Some 15,000 households out of 17,000 have contributed Rs. 5,000 per household representing one third of the project cost. A notable feature i s the tariff structure, developed on full user charge recovery with cross subsidies for the poor. The first community participationproject, has also suffered a number o f set backs due to some lack of forward planning, i.e. delays in selection of an operator for O&M o f the sewerage scheme; miscommunication on the distinction between upfront payment o f capital cost through communityparticipation and a separate connection fee to eachhouse to be leviedseparately. These are lessons, which can be incorporated inrepeat o e TheEast-Coast Highway Project on road upgrading, Tamil NaduRoadDevelopment Company (TNRDC) was set up in 1998to catalyze private sector investment inthe road sector and commercialize O&M. Its equity o fRs.10 crores was split 50:50 betweenpublic andprivate funds. The first upgradingproject financed by TNRDC i s the 113 Km.longEast CoastRoad(ECR) connecting Chennai and Pondicheny at a cost o f Rs 60 crore. A Rehabilitate-Improve-Maintain-Operate-Transfer (RIMOT) framework was applied and commercial operations onthe road commenced inMarch 2002. TheRIMOT frameworkrequires user chargesto recover improvement andmaintenance costs only, leadingto lower tolls; project returns are capped at 20% and surplus ifany, i s reinvested inthe road sector inTamil Nadu. e TamilNadu Urban Development Fund (TNUDF)for credit enhancement capital market financing of urban infrastructureprojects. Financed through a World BankLoan, GoTN LineofCredit, andequityfrombanks in1996, the Fundhadapproved loans ofRs.492.27 crore as of March2003. Notable projects ar adurai RingRoad, and Pooledfinancing for smaller towns for wat ste contracts and storm TNUDFhas structured investments es on the basis o f gcapabilities o fUrbanLocalBodies intechnical and acity enhancement of ULBs.The few privately contracted projects have so far hada good track record of implementation. TNUDFlendsto oseULBswhich are recePtive to undertaking institutional and financial reforms. 10 27. Reinvigorating agriculture growth. This remains critical since a vibrant agriculture sector encourages industrial growth and farm income accounts for 78% o f the income o f the poorest 20 percent o f the rural population. Traditional sources o f agncultural growth, however, face major constraints including growing water scarcity, increasing land degradation and declining farm sizes, and rising costs o f agricultural labor (Box 1.2). Given water scarcity, diversification into less-water intensive higher-value products i s the most promising avenue for future agncultural growth. Broader institutional and policy reforms are required to efficiently manage scarce water resources, decentralize a traditionally top-down centralized extension systemto respond to diversified agriculture, improve rural infrastructure to facilitate efficient markets, and reorient public expenditure towards growth-enhancing areas such as rural roads, markets and agricultural research and extension. This requires to be combined with appropriate levels o f cost recovery for water, power and other inputs and safety expected loss o f farmers' income in the transitional period. Box 1.2: Challengesto SustainingAgricultureGrowthinTamilNadu Tamil Nadu i s one o f the driest states in India, with an average o f only 925 millimeters o f rainfall per year. The state has a dry season that extends over five months of the year (January through May) even in good years, and severe droughts occur in three out of every ten years severely limiting cultivation o f crops between the months o f June and September. The per capita availability of water resources o f Tamil Nadu i s only 900 cubic meters compared to an all-India average o f 2200 cubic meters per annum. Irrigation through a combination o f canals, tanks,' and wells, increases the reliability and availability of water for farming, and i s essential for successful cultivation o f crops inmuch o f the state. Nonetheless, seasonality o f supply and scarcity o f water limit cultivation to only one crop per plot for most o f the state.' Inaddition to growing water scarcity, the agricultural sector faces increasing competition for water from industries and domestic users and intensifyinginterstate competition for surface water resources. Inmany parts of the state, the rate of extraction of groundwater has exceededrecharge rates contributing to falling water tables. Water quality issues are also o f increasing concern. Effluents discharged from industries as well as heavy use o fpesticides and fertilizers have had a major impact on surface water quality, soils and groundwater. Agricultural land resources have also come under increasing pressure because of rapid population growth and increasing urbanization. The available cultivable land per rural resident has declined from 0.22 hdcapita to 0.15 hdcapita between 1971172 and 1997198. The growing pressures on land coupled with skewed pricing policies and rural poverty have contributed to land and soil degradation. As a result, poor soil fertility, salinity, water logging, over grazing, and deforestation are growing problems and pose serious constraints to the performance of the Iagricultural sector insome parts o f the state. Source:Tamil Nadu Agncultural Development, World Bank (2004) 28. Improving public administration and enhancing service delivery. Although Tamil Nadu has one of the better records in public administration and service delivery among Indian states, the state i s not immune to problems common across Indian states. To support the fiscal reform and the reform o f the investment climate, the reform would also need to focus on strengthening the effectiveness o f the government by rationalizing its role and responsibilities, simplifying decision-making processes, improving the stability o f staff tenure, and enhancing critical services delivery-which have a large public interface through a combination o f measures such as agency reform, e-governance, and public private partnerships. Further, the reform would need to address the transparency o f the government and 11 anti-corruption, through a major overhaul o f the public procurement system, enacting new "Right to Information" legislation, and strengthening the anti-corruption machinery (Box 1.3). Box 1.3: Some important Governance and ServiceDelivery Challenges inTamil Nadu Tamil Nadu has registered some o f the best human development indicators inIndia after Kerala. A recent survey conducted by Bangalore's Public Affairs Center (PAC) reveals that it possesses the country's best public distribution and school education systems, and the second best public drinking water and road transport services after Gujarat. This, o f course, i s not a uniformpicture: health services, for example, are ranked fifth. One keyissue is the proliferation o fthe bureaucracy which has grown exponentially inthe last twenty years. In order to get a grip on the problem, GoTN appointed a Staff and Expenditure Commission (SERC) to suggest ways o freducing the size o f the civil service. SERC has submitted all its reports, which pinpoint redundant positions in Tamil Nadu's 140 field departments, as well as the Secretariat; recommend strategies for rightsizing, such as redeployment, compulsory retirement, and a targeted form o f VRS; and proposes broader reforms to enhance efficiency, such as faster file movement, more delegation to field offices, and outsourcing several tasks. T h e civil service faces a problemo f fiequent transfers that undermine service delivery by disrupting managerial continuity and generate corruption. This is also a national phenomenon and different states have attempted to tackle it in different ways. For instance, GoTN has responded to this problem by introducing a system o f formal counseling for transfers inboth the Health and Education Department to reduce discretion intheprocess. Butfurther steps couldbetaken, particularly le ation to ensure a normal term o f three year place quantitative limits on transfers inthe aggregate and by cadre, and create statutory boards andor transferring authorities to better streamline the transfer process. A databaseto systematically monitor transfers is necessary. TamilNadu was the first state to pass a comprehensive law to regulate procurement and ensure access to information. The procurement law is sound and GoTN has recently begun further reforms, such as creating standard bidding documents and harmonizing codes and rules across government with the procurement law. Tamil Nadu was also the first state in the country to adopt a Right to Information (RTI) law in 1997: The law, however, was seriously flawed and GoTN has now decided to replace it with a new and better law. GoTN has also used its website to provide a wealth o f information to the public, including Government Orders, laws andrules, and informationon departments and agencies. On the other hand, Tamil Nadu's anti-corruption institutions need strengthening. GoTN's HighLevel Committee on Administrative Reforms andthe Preventiono f Corruption inits 1997 report recommended the creation o f an independent Vigilance Commission. The best example o f a successful independent anti-corruption institution i s Karnataka's Lok authority to investigate both c ases and grievances arising ation involving civil servants ters; exercises supervisory the police wing ,and possesses a Source: Tamil Nadu: Governance Challenges. World Bank. 2004. 29. Strengthening poverty monitoring and evaluation. The broad structural reform program needs to be supported by protecting the poor and vulnerable through targeted interventions. The Tenth Five-Year Plan provides a detailed description o f the poverty-reduction programs, which are wide ranging, to cover health, education, water supply and sanitation, and food security. These programs include schemes targeted to particular social and demographic groups such as scheduled castes and tribes, women and children. The specific interventions broadly match the spatial and social needs revealed by the poverty 12 diagnostics although there i s scope for improving the design and targeting efficiency. To this end, strengthening poverty monitoring and evaluation for effective targeting i s an important focus area. For example, developing strong institutional capacity for evaluation based leaming i s invaluable for improving the targeting in schemes such as the Public Distribution System. Similarly, building institutional capacity for an effective monitoring and feedback mechanism that ensures aligning o f budgets to priority needs in education, health and broader aspects o f service delivery will be important in the coming years. 30. Impact of reform on growth and poverty: 0 Fiscal correction and sustainability can exert a positive impact on economic growth and poverty reduction in four ways: (i) by reallocating public expenditures from consumption to growth- enhancing and poverty-reducing productive spending; (ii) by strengthening public expenditure management to help increase the efficiency o f public spending; (iii) by achieving a sustainable and transparent fiscal environment and increased spending on infrastructure that encourages private investment, including private spending on critical infrastructure and basic services; and (iv) by creating and protecting the fiscal space for the various targeted poverty-reduction programs envisaged inthe TenthPlan. 0 Streamlining business regulations and improving infrastructure will improve the investment climate for private sector development. This particularly benefits medium and small enterprises as complex regulation and infrastructure bottlenecks tend to disproportionably affect smaller businesses. The acceleration o f economic growth led by the private sector remains fundamental to poverty reduction. 0 The reform component o f public administration and service delivery will help address issues o f common concem for all critical infrastructure and service delivery sectors relevant to poverty reduction. Streamlined government functions, simplified decision malung, the stability o f staff tenure, and transparency and anti-corruption measures would all contribute to improved service delivery and poverty reduction. 0 The government's strengthened capacity to manage the reform process-including the capacity to evaluate and monitor major poverty-reduction interventions and link policy, expenditure and poverty reduction-will help strengthen targeted poverty-reduction interventions to the poor and disadvantaged groups. 13 11. ACHIEVING FISCAL CORRECTION AND STABILIZATION Tamil Naclu's Fiscal Reform 31. Facing an unprecedented fiscal crisis, the Government o f Tamil Nadu launched a program o f fiscal correction and stabilization in 2001. To quote the August 2001 White Paper of the Government o f Tamil Nadu: "Without a firm commitment to fiscal discipline and prudent management o f State finances, no Government can fulfill the mandate to it by the pe0p1e.l'~The White Paper, tabled and debated in the state legislature, analyzed the systemic causes of the fiscal deterioration and articulated the need for fiscal reform and stabilization. Substantive reforms were undertaken from late 2001/02 to 2003/04. However, electoral defeat in the national election in Apnl-May 2004 led to the rolling back o f reforms. The rollbacks have resulted in: free power being restored to all farmers, substantial reduction in electricity tariff for domestic consumers, restoration o f freeisubsidized bus travel to private school and college students, and withdrawing PDS targeting by imposing income ceiling and rice coupons in favor o f universal coverage. Minor ones have included withdrawing hospital visiting fees and outpatient charges. It i s uncertain how far the roll back would go. The rollback o f key subsidy reform policies mean the government's projected medium-term fiscal adjustment will prove difficult to achieve unless policy reforms that underpinned the MTFP are perseveredwith. 32. Paragraphs below summarizes critical elements o f the fiscal reform: the development o f a multi- year framework for fiscal adjustment; improving legislative oversight and fiscal transparency; improving the efficiency and equity o f the tax administration and rationalizing user charges; reorienting expenditure from current consumption to growth-enhancing and poverty-reducinginvestment; reforming state-owned enterprises and ailing cooperatives; and strengthening public expenditure management and financial accountability to increase the efficiency o f public spending. 33. Development o f a medium-term fiscal program. The annual budget o f the state Government, as in other states, did not reflect a medium-term perspective. The budgeting process was an incremental exercise with no clear links between policies, budget, and outcomes. Fiscal accounting, being on the mandated cash system, did not fully capture deterioration in the fiscal condition, owing to non-reporting o f accrued liabilities (arrears and nonpayment o f actual expenditures as in 1999/2000, 2000/01, and 2001/02) and contingent liabilities, such as guarantees. Financial losses of the state-owned enterprises were not consolidated with the state government's accounts, which therefore provided an incomplete picture o f the underlying fiscal trend. 34., The state legislature enacted a Fiscal Responsibility Act inMay 2003, the thirdIndian state to do so. The Act set fiscal targets for reducingthe budget fiscal deficit to 3% o f GSDP and the revenue deficit to revenue receipts to a level below 5% by March 31, 2008, and capped risk-weighted guarantees at 75% o f revenue receipts of the previous year, or 7.5% o f GSDP. The GoTN also signed a Memorandum o f Understanding (MOU) with the Go1on the State's Fiscal ReformFacility in September 2003, which set a path for sustained reduction inthe ratio o f the revenue deficit to revenue receipts. 35. Guided by the Fiscal Responsibility Act, the Government o f Tamil Nadu developed a first medium-term fiscal program (MTFP), a five-year framework, which was envisioned to be an annual rolling document institutionalizedinto the budget formulation process. The first MTFP was presented to the state legislature in February 2004, along with the state's budget for 2004/05. Subsequent MTFPs 'White Paper onTamilNaduGovernment'sFinances,GovernmentofTamilNadu,August 2001. 14 were envisioned to be presented with subsequent annual budgets, along with reports on performance against targets. 36. The MTFP explicitly incorporated important off-budget activities and other contingent liabilities into the multiyear adjustment framework. First, the accounts o f the Tamil Nadu Electricity Board were consolidated with the Government's budget to arrive at a consolidated deficit. Second, off-budget borrowing serviced by the Government o fTamil Naduwas integrated with the state's public debt.8 Third, capital work executed from the Public Account but financed from off-budget borrowings through Public Deposit Accounts, thus distorting the fiscal deficit, were fully integrated within the fiscal framework. Fourth, comprehensive and robust estimation o f accrued pensionliabilities and emerging cash flow needs basedon the inherent demographics o f the workforce replaced ad hoc incrementalbudgeting. 37. The process i s not complete and steps need to be taken to further improve fiscal transparency. The current practice o f reporting cash deficits by Indian states limits the scope for reporting accrued liabilities. The fiscal deficit and its financing need to be consistent with international practice. Budget documentation needs to be improved to present departmental policy objectives, major programs, performance goals, and associated funding, together with subhead- and program-level budget estimates for department grants. All essential fiscal information will need to be posted on the Web for public access, including the Accountant General's fiscal accounts for the state, with supplementary comments on guarantees, payment arrears, off-budget borrowings, accounts o f the state-owned enterprises, and the outcomes o f periodic reviews o f subsidies. The Government has begun tabling a bi-yearly review o f the budgetinthe state's legislature, which has also beenpublicly releasedonthe Government's website. 38. Prudent management o f guarantees i s an essential part o f the medium-term fiscal adjustment. The 2002/03 budget classified and reported guarantees by risk weight for the first time. The next step would be to establish an institutional framework for screening competing demands for the issue o f guarantees while staying withinthe limits set by the Fiscal Responsibility Act. 39. The MTFP is underpinned by a continuation and deepening o f taxation and expenditure reform, and reforming state-owned enterprises and cooperatives to reduce subsidies and liabilities. But recent decisions extending free power to all agriculturists, slashing power tariff to domestic consumers to pre- reform levels o f 2001 (expected to cost government about Rs. 920 crore in 2004/05), withdrawal o f PDS targeting (will raise food subsidy by about Rs. 130 crore in 2004/05), restoration o f transport subsidy (student bus passes & concession fare will cost Rs. 125 crore in 2004/05), constitute reform setbacks. They bring into question the validity o f the MTFP and the commitment o f the government to fiscal reform. 40. Reforming the taxation system. The potential for substantially increasing the tax revenue inTamil Nadu i s limited for three reasons. First, Tamil Nadu's own tax revenue effort is already among the highest in Indian states. Second, India's Constitution places limitations on the taxation power o f states. The fastest growth sector in Tamil Nadu is the services sector, taxation of which is reserved for the central Government. Third, successive central Finance Commissions have reduced the share o f Tamil Nadu in the pool o f net shareable central taxes, from 8 percent (Seventh Finance Commission) to 5.4 percent (Eleventh Finance Commission). The contribution o f the share o f central taxes to Tamil Nadu's revenue declined from 21percent in 1992/93 to 15 percent in2002/03. 41. There is, however, considerable scope to improve the efficiency, equity, and administration o f the state tax system (Box 2.1). Inparticular, the state's sales tax (63 percent o f the state's own revenue) The stock ofoff-budget borrowings inthe public account, though unsubstantial relative to other states' (for example Kamataka and Maharashtra), constituted 2 percent o f 2002103 GSDP. 15 consists o f sales tax, entry tax, resale tax, additional tax, and surcharges, which imposes higheffective tax on inputs with no rebates and results in a negative cascading impact on manufacturing costs. The entry tax on goods into local areas from outside Tamil Nadu negatively affects trade and investment. The relatively high stamp duty on immovable property encourages evasion and value under-reporting in property transactions. The tax administration imposes high compliance costs because o f its lack o f self- assessment for large businesses, lack o f electronic filing, and protracted dispute resolution procedures, which encourage undesirable frequent contacts between businessmen and tax officials. 42. To provide an overall policy framework for reforming tax policy and administration, the Government established a Tax Reform and Revenue Augmentation Commission inJune 2002, headed by the well-known Dr. Rajah Chelliah. The Government has begun implementing key recommendations o f the Commission (e.g., the stamp duty on immovable property). The introduction o f the VAT to replace the current sales tax system should resolve the main problems related to the state's sales tax system. Tamil Nadu i s at an advanced stage of preparing for the introduction o f the VAT set for national introduction on April 1,2005. 43. Onthe next important reform area, the Government o f Tamil Naduhas reducedthe stamp duty on immovable property to a uniform 6 percent, from 8 percent in urban areas and 7 percent in rural areas. The transfer duty on immovable property, which was set at a uniform 5 percent, has also been reduced to 2 percent. The effective stamp duty i s hence a uniform 8 percent, down from 12-13 percent. To identify measures to maintain revenue neutrality following the rate change, the practice o f duty avoidance and evasion schemes and the impact o f the reduced rate on conveyance o f immovable property on revenue collection will need to be reviewed. Reforms also need to be planned for other taxes and duties (such as stamp duties on other dutiable instruments) based on systematic review o f these taxes, takmg into consideration efficiency, equity, and collection costs. 44. Excise revenues are derived mainly from privilege fees on Indian-made foreign spirits, excise duties, and fees on liquor. The Tamil Nadu State Marketing Corporation has the exclusive right o f wholesale and retail supply o f Indian-made foreign spirits for the state and i s responsible for collecting the excise duty. The overall tax burden on liquor i s highbut largely comparable with those in other states in India. Given that Tamil Nadu maintains a .public monopoly responsible for collecting excise duty directly from a small number o f distilleries, there i s no evidence that the high effective tax rate induces widespread evasion that would put the revenues on the wrong side o f the Laffer curve. Reforms couldbe envisaged regarding the calculation o f excise duties, switching from a specific to an ad-valorem excise, following the Maharashtra example. 45. Entrytaxes on motor vehicles and goods riskhaving an unintended negative impact on trade and investment. They hinder inter-state trade, induce a high-cost state economy, and negatively affect the competitiveness o f Tamil Nadu as an investmentlocation. As a revenue source, they are insignificant and arejustified primarily as an additional means o f fostering sales tax compliance. The business community inTamil Naduhas asked that the entry taxation be abolished once the VAT is introduced. This request is fullyjustified. 46. Buildingon the ongoing efforts to improve the tax administration, a medium-term action plan i s being formulated to reform the tax administration. It focuses on improving corporate planning, strengthening human resources, and restructuring the tax administration, moving it from focusing on enforcement to service-oriented compliance. Annex Ihas details o f a suggested plan for improving Tamil Nadu's Tax Administration. 47. Improving non-tax revenue. Revenue collection in Tamil Nadu relies primarily on the state's own tax system (70 percent o f total revenue). Another 15 percent o f revenue comes from shared central taxes devolved to Tamil Nadu. Only 7 percent o f total revenue i s from non-tax revenue. Tamil Nadu 16 ranked low in non-tax revenue relative to 14 major Indian states (1985-2000). Some user charges (such as bus fare) do not go directly to the state's treasury but are collected by state-owned enterprises, and regular revisions o f these charges could reduce the required budgetary support. Although low non-tax revenue indicates the potential for increases, such decisions are frequently constrained by political difficulties. Source: Tamil Nadu: Improving Investment Climate, World Bank, 2004 49. Reforming the pension system and rationalizing salary expenditure. Tamil Nadu has the highest number o f civil servants per hundred people o f any major Indian state after Punjab: 2.13 compared with 17 1.4 for the country as a whole. While the roots o f overstaffing can be traced to decisions made in the 1980s, its negative impact on the current salary and pension structure adds to the current fiscal stress. As a result o f implementing in April 1998 the Sixth State Pay Commission, pension and salary growth accelerated and appropriated an ever larger share o f the state's revenue in 199912000: 56 percent o f the state's revenue expenditure, 68 percent o f the state's total revenue, and 91 percent o f the state's own tax revenue. Worse, these shares underestimate real liabilities, as a liquidity crisis in 1999/2000 forced the Govemment to postpone sizable payments o f salary and pension (Rs. 1,823 crore to employees who retired between January 1996 and March 1998) for five years. The present Govemment started to clear these dues in2003104. 50. To address the rapid growth o f salaries and pensions, the most serious threat to fiscal sustainability, the Government adopted a number o f measures. A Staff and Expenditure Reform Commission was established in December 2001 to systematically identify surplus positions, posts, functions and departments for redeployment and streamlining (Box 2.2). The Commission has identified about 85,000 surplus posts and 113,000 vacant positions, while 10 departments have been identified for closure. The Commission's reports on 140 departments and agencies are under review. Box 2.2: Staff andExpenditureReformsCommission There are four key features o fthe SERC's working that bear comment. First, the SERC experience is fundamentally an in-house assessment o fredundancy, unlike the externally-driven assessments conducted by consultants supervisedbythe Administrative Reforms Commission (ARC) in Kamataka, the Institute o fPublic Administration inPunjab, and consultants inOrissa. Second, the SERC reports, which focus onboththe Secretariat and 140 field departments provides the most targeted identification o f surplus posts inany state that has attempted suchan exercise, far morepin-pointed than the externally-conducted analyses inKamataka, Punjab, andOrissa, which have proven less useful inidentifjmgopportunities for pruningstaff. The criteria for regarding a post as surplus include: (a) assessingposts inrelation to existing work norms, (b) establishing new work norms inthe light o ftechnological change, and a concomitant reductioninstaff, (c) analyzing whether a department needs to performa particular function at this time and adjusting staff size accordingly, and (d) reducing posts bypromoting outsourcing across government. The Commissionpared about 23% ofall Group A posts, which constitute only 1.7% ofthe core civil service (excluding non-pensionable employees); 12% o f Group B posts (10.04% o f core), 9% o f Group C posts (75.3% o fcore), and40% o f Group D (13% o f core). Staff cuts were thus highly disproportionate for Groups A andD and mildly so for Group B; Group C, includinga large contingent o fteachers, faced only a small cut relative to its share o f the civil service. Third, the process o fformulating the reports was markedby extensive consultation. The SERC reviewed approximately 10 departments a month; for each department, the process involved aninitial round o fconsultation withthe Secretary and DepartmentalHeads (HOD'S), followed by intensive discussions with lower-level officials andunions, and a concluding wrap-up session with the Secretary. Staff associations were asked to fillout a separatequestionnaire asking themto evaluate the merits o f the single-file system and level-jumping; identifyareas for decentralization o f authority within departments; re-evaluate work norms inthe light o fnew technology; indicate areas o fexcess or inadequate staffing; ctions best done only by government, by government andNGO's or the private sector e private sector alone. StaffAssociations were also asked to suggestways o fre tive costs generally. The Commission receivedhundreds o f suggestions on rationalization from the public via its website. The expert prob Chairmaninin-depthinterviews with department officials, high and low-level, c derived from the questionnaires, yielded inside information on redundant and/or conferred legitimacy on the exercise. Source: Tamil Nadu Governance Challenges, World Bank 2004. 18 51. A ban has been imposed on the creation o f new posts and a freeze declared on the creation and filling o f vacancies through direct or compassionate appointments, except for essential staff (teachers, health workers, police). In another move, 23,123 live posts (road gang workers and people's welfare workers) were abolished. After the Commission's review, the Government issued orders to abolish 40,500 surplus posts in vacant positions created by the hiring freeze. The remaining surplus posts are to be abolished over the next few years mainly through attrition andredeployment o f staff. The Government also rationalized employee compensation and benefits by withdrawing surrender leave encashment and the annual Pongal Bonus, and has delayed the announcement o f additional Dearness Allowance installments (always with prospective effect). However, in a recent setback (post national elections) the Government decided to retain the services o f 15,500 temporary employees who were recruited during a civil servants' strike in2003 malung further employee restructuring efforts more difficult. 52. The Government also carried out pension reform to reduce current and contingent pension liabilities: a defined contribution system for employees hiredafter April 1,2003, has been introduced, the qualifying tenure o f service required to receive full pensions has been increased by three years, and the basis for calculating eligible pensions was changed to the last 10 months average pay rather than the last drawn pay. The Government o f Tamil Naduhas carried out a massive exercise to collect data and project pension liabilities and cash flows under the various retirement programs, not only for the state civil service but also for local bodies and major state-owned entities such as the Tamil Nadu Electricity Board and the State Transport Corporations.' This has enabled a comprehensive and robust estimation o f pension liabilities and emerging cash flow needs, which take into consideration the demographics o f the workforce. 53. The Government o f Tamil Nadu has already issued a Government Order establishing a new definedcontribution scheme for all civil servants hiredwith the status o f pensionable service after April 1, 2003. The Government of Tamil Nadu is loolung to developments at the Govemment o f India level, both for detailed parameters and rules and institutional arrangements (recordkeeping, investment policy). But given the relatively slow state o f progress, it may be necessary to develop interimarrangements so that the new scheme can be implemented soon after the new entrants recruited since April 2003 will have passed through their probationary period and become eligible for: pensionable service. The implications and potential costs o f different options are beingreviewed. 54. Rationalizing subsidies and improving targeting. Direct subsidies were the third fastest growing revenue expenditure, next to pensionand interest expenditure. The largest subsidy went to food (of which the rice subsidy accounts for 90 percent) distributedthrough the public distribution system (PDS). Food subsidies accounted for 67 percent o f direct subsidies or 8.5 percent o f the state's revenue in 2000/01. The PDS is probably the most important safety net program in India. A survey conducted by the Public Affairs Center" shows that Tamil Nadu's PDS ranks first inthe country on several parameters, including access, usage, and reliability. Tamil Nadu's PDS had universal coverage until 2002, with all 16 million families inthe state entitledto the PDS. 55. Substantive PDS reform was undertaken from 2002 to 2003, but the reform has suffered a setback. Rice procurement by the state through the Tamil Nadu Civil Supplies Corporation has been replaced by purchases from the Food Corporation o f India, saving milling and inventory costs and lowering the cost o f purchase. Production incentives given by the state over the minimum support price set by the Government o f India have been eliminated. About 4 million out o f 16 million families have chosen to opt out o f PDS rice through a self-selection scheme. Rice coupons were then introduced to 'The pension exercise i s the largest among the Indian states the Bank has beenworking with. The quality and speed of data collection are impressive. loA well-known NGO inIndia. 19 reduce the number o f households eligible for PDS rice further to 10.4 million. Income criteria to determine PDS eligibility-monthly household income o f Rs.5,000, income tax and sales tax assesses- was introduced in 2003 for voluntary compliance. Butboth rice coupons and income targeting have been withdrawn by the GoTN after the national election in April-May 2004. The PDS coverage i s likely to increase to 12 million and the food subsidy bill to Rs. 930 crore in2004/05, which i s below the maximum subsidy amount o f Rs.1,540 crore incurred in 2000101 but higher than the projected Rs. 768 crore inthe MTFP. 56. Reforming public sector unitsand cooperatives. Implicit subsidies and fiscal support to the public sector enterprises and cooperatives (through, for example, low user charges, interest subsidies, and loan write-offs) and guarantees to these entities have led to growing contingent liabilities. State transport units, with 120,000 employees and an accumulated loss of Rs.2, 090 crore as o f March 2002 (Rs. 2,166 crore as o f March 31, 2004), accounted for about 70 percent o f employment and 73 percent o f accumulated losses o f all public sector units in 2001/02. The 18 cooperative spinning mills and 16 cooperative sugar mills, employing 20,000 people, dominate the financial losses incurred by the cooperative sector. There are also nine public Statutory Boards formed under independent legislative acts, spanning from electricity to maritime transport to pollution control. The TNEB, accounting for 80 percent o f employment o f the nine Statutory Boards, and dominates the balance sheets. 57. The state's strategy for reforming the state transport units (STUs) comprises improving internal efficiency, downsizing the work force, adjusting the fare structure, and implementingpartial privatization. Public transport bus fare was increased by 27 percent and annual bonus and ex gratia payments to STUs employees were cut from about 20 percent to the statutory minimumo f 8.33 percent. The crew-to-bus ratio has been reduced from 7.9 to 7.6. The STUs have been consolidated from 18 state transport units to 7 which i s expected to result in a saving o f 10 percent on overhead cost. As a result, the financial performance o f the state transport units has improved somewhat though not consistently. In2002/03, the STUs incurred a loss o f Rs. 4 crore showing an improvement in Performance, but in 2003/04 there appears to have been a slide in performance with a pre-audit loss figure o f Rs. 32 crore. Further reform plans include: rationalizing the crew-to-bus ratio to reach a target level o f 6.5, and implementing a phased program o f privatizing 20 percent o f routes. 58. The Government announced a policy decision to exit all manufacturing public sector undertakings (PSUs) and sick cooperative spinning and sugar mills, following the Go1 framework and guidelines for VRS prior to closure and divestment. To facilitate divestment, institutional mechanisms, the Cabinet Committee on Divestment and a high-powered Interdepartmental Committee on Divestment have been established. A legislative amendment to the Tamil Nadu Cooperative Societies Act, enabling sale o f assets o f sick cooperatives, has also been passed by the state legislature. All cooperative spinnindsugar mills identifiedfor closure are sick mills. 59. Eightpublic sector undertakings, eleven out o f eighteen cooperative spinningmills and two out o f sixteen cooperative sugar mills have been closed. The VRS has been accepted by 8,426 employees. The VRS has also been accepted by 2,554 employees in twelve more public sector undertakings enabling restructuring o f these entities. The Tamil Nadu Industrial Explosives Limited was chosen to be privatized first but progress has been slow. Counselinghas been initiated for the retrenched employees. 60. The Tamil Nadu Electricity Board. The Tamil Nadu Electricity Board (TNEB),a state monopoly, i s relatively efficient in the Indian context. With the second largest power market in India, per capita consumption o f electricity in the state i s 567 lulowatts a year (national average o f 355 kilowatts). In 2001/02, 61 percent o f the electricity was sold on a metered basis-much better than in other states (34 percent in Karnataka, 41 percent in Andhra, 39 percent in Gujarat, and 47 percent in Maharashtra). Technical and distribution losses are about 18 percent, muchlower than those inmany other Indian states. 20 The TNEB has an active enforcement system to penalize power theft. Collection efficiency has been consistently high (about 98 percent). 61. Yet financial losses rose steadily from Figure2.1 :TNEB'sFinancialPerformance 1997/98 to 2001102. Earnings before interest, Trend depreciation, tax, and amortizations (EBIDTA) turnednegative in 199912000, reaching negative loo0 1 Rs. 1,225 crore in 2001102 (Figure 2.1). The distress i s attributed to increasing power 0 purchases costs and increasing cross- subsidization. Sales to subsidized categories ie 2 (1°00' (residential, agriculture) grew rapidly while the subsidizing HT industrial sales remained stagnant with increasing dependence on self- generation. The state has a 2,475 megawatt (3000)J Y captive generation capacity. From 1996197 to 2002/03, the proportion o f purchased power to total power input increased from 31 percent to 1 WEBIDTA I 48 percent. OProfit before subsidy 62. At the same time, the average cost o fpurchases increased from Rs.1per hlowatt-hour to Rs.2.68 per kilowatt-hour, largely because o f high-cost Independent Power Producers (IPPs). The severe droughts in 2001 and 2002 depleted cheaper hydro resources, forcing their replacement with more expensive thermal power. 63. The financial distress constrains the TNEB's ability to make investments, resulting in generation shortage and uneven quality o f supply. As in many other Indian states, long-term PPAs for contracting generation capacity have not worked well and have resultedinhigh IPP tariffs. Inits recent tariff order, the Tamil Nadu Electricity Regulatory Commission directed the TNEB to explore options for reducing IPP tariffs to more reasonable levels. 64. A number of initial steps were undertaken from late 2001 to 2003. The Government made the Tamil Nadu Electricity Regulatory Commission functional in 2002. Two tariff adjustments-a 16.5 percent increase in December 2001 and a 13.5 percent increase in March 2003 (latter by the Commission)-have helped to reduce cross-subsidies and improve the financial health o f the TNEB. All new agnculture consumers were metered from July 2002. The Government also brought onto its budget Rs. 1,962 crore o f the TNEB's past duesto centralpower utilities to clean upthe TNEB's balance sheet. 65. Reducing agriculture cross subsidies in the power sector has proven to be extremely difficult. If cross-subsidy issue i s not addressed, then either the state budget would have to bear an increasingly larger subsidy burden or the tariff o f subsidizing users (e.g., industrial and commercial users) would have to be increased. Increasing industrial power tariff, which i s already high, would force more industrial and commercial consumers to leave the state utility grid, putting further pressure on the state utility's finances. When implementing the agnculture tariff set by the regulator in March 2003, to reduce the negative impact o f the tariff on small and marginal farmers, the Government implemented a direct subsidy scheme for smallholders and marginal farmers (Rs.lOO crore) and hut dwellers (Rs.14 crore), a significant experiment toward a direct and transparent subsidy system. Even then the bulk o f the subsidy burden (about Rs. 3,500 crore) rested with the TNEiB. Agriculture metering and the introduction o f power sector tariff for agriculture became contentious political issues inTamil Nadu duringthe M a y 2004 national elections. Following the elections, GoTN followed Andhra Pradesh in announcing free power to farmers thus reversing the nascent reforms. The Government also reversed its earlier 30% increase inthe tariff for domestic consumers. The experimental direct subsidy to farmers was given up in favor o f 21 budget support to the TNEB for costs incurred towards free power to agriculture and hut dwellers (Rs. 114 crore) as well as subsidizedpower to domestic consumers. 66. The reversal in the tariff for domestic consumers will have a much larger immediate fiscal impact: o f about Rs. 720 crore. With tariff increase unlikely inthe next few years, given recent events, overall losses could exceed the reformist business plan by Rs.923 crore in 2004105 to Rs. 2,034 in 2006/07 under a conservative scenario. Under more aggressive assumptions, losses could be higher by Rs. 1,200 crore in 2004105 climbing to Rs. 2,681 crore in 2006107. This o f course assumes there is no financing constraint. Budget support o f this order to finance TNEB's resource gap will strain fiscal recovery. Financing TNEB's resource gap through state guaranteed borrowing would increase GoT"s contingent liabilities and financing costs o f TNEB besides the high opportunity cost that this involves in terms o f resource misallocation. In any situation the financial recovery o f TNEB i s unlikely to be sustained, investments are likely to be constrained, and finances and service quality are likely to deteriorate. Further, inboth scenarios, the consolidated fiscal deficit will be back at or above pre-reform levels, and productive spending will be crowded out by power subsidies. 67. The long-term financial sustainability o f the power sector in Tamil Nadu, as in other Indian states, will require the formulation and implementationo f a comprehensive reform program that addresses the requirements o f India's new Electricity Act 2003-including competition in the power sector and metering all un-metered consumers. But detailed implementationarrangement o f the Act remains unclear inkeyaspects. 68. Institutionalreform of, and restructuring requirements for, Tamil Nadu's power sector need to be developed and implemented in accordance with the provisions o f the National Electricity Act and the specific needs o f the state. Key aspects to be addressed include the generation cost, the ability to attract sustainable private investment, and human resource requirements. 69. The experience o f metering existing consumers in other states has generally been unsuccessful and will remain politically challenging in Tamil Nadu as well. A consensus i s emerging that introducing metering o f agriculture pump sets requires an integrated solution that incorporates water and power issues and demonstrates improved efficiency o f pump sets and better delivery o f paid-for services (power, irrigation, extension, post harvest marketing), resulting inhigher farm incomes. 70. Improvingpublic expenditure management. The Government of Tamil Nadu has initiated reforms o f the systems and processes o f budget formulation and execution. While the existing annual budget system is functional, reforms are needed to achieve the Government's development objectives and to adapt the institutional arrangements to support the fiscal strategy. The key challenge i s to ensure that a comprehensive resource framework and a medium-term perspective effectively guide the three objectives o f budget management: aggregate fiscal discipline inline with the medium-term fiscal program, strategic policy decisions by the Government within the constraints o f the fiscal program, and efficient use o f public expenditure in government operations. Ineach o f these areas, the Government o f Tamil Nadu has initiated or proposedmajor actions. 71. The Tamil Nadu Fiscal Responsibility Act (FRA) lays the foundation for aggregate fiscal discipline by emphasizing transparency and disclosure o f the medium-term fiscal program with each budget. In addition to the required political commitment to the fiscal adjustment, credible medium-term fiscal planning will require strengthened government capacity to project revenue over a multiyear period, and key indicators such as the fiscal deficit will have to be made consistent with standard international practice to be fiscally transparent and to facilitate monitoring of fiscal trends. International experience suggests that fiscal responsibility legislation i s neither essential nor sufficient for fiscal adjustment, but that it can be a useful institutional complement to fiscal policy reforms. Performance in the four other Indian states that have so far passedFRAs (Karnataka, Kerala, Punjab, and Uttar Pradesh) has been mixed 22 with different levels of ownership and commitment. More attention will be requiredboth by government and by outside parties to comply with FRA provisions post-adoption. 72. To improve the strategic budgetary tradeoffs on policy initiatives, Tamil Nadu needs to substantially strengthen its upstream capacity for policy formulation. Government departments inTamil Nadu prepare specific policy notes to set out government sectoral objectives and articulate how government expects to achieve its objectives through service delivery, financing, partnership, or regulation o f private activity (Box 2.3). Such policy notes, appropriately strengthened in process and content, could form the basis for linhng the government's objectives inspecific sectors with departmental budgetary preparation and financial requirements. This is necessary to ensure that well-crafted departmental policy proposals, together with their financial implications, are submitted for cabinet review and discussion during budget formulation. The establishment o f a Policy Review Committee, to be chaired by the Development Commissioner, could provide leadership and focus to this key capacity- enhancing reform. The Policy Review Committee can rely on a network o f public and private institutions to undertake public policy research and analysis. An appropriately staffed cell o f the Planning and Development Department can be established to develop and maintain the network relationship with institutions. 73. Current processes for budget formulation inTamil Nadu distinguishbetween existing expenditure commitments (Part I) and new expenditure commitments (Part 11)-mahng them extremely amenable to adaptation to improve cabinet decision-making on policy priorities within the medium-term fiscal program. The Standing Finance Committee o f Cabinet can be made responsible for reviewing new policy and project commitments under Part I1o f the proposed budget and ensuring that priorities are funded within the agreed fiscal constraint. Current budget instructions require departments to submit multiyear budgets for both Part Iand Part 11. In subsequent years, the budget documentation needs to be improved to provide a clearer linkbetweenpolicy priorities and goals, budget allocations and performance. 74. The operational efficiency o f government departments is a function, among other things, o f the predictability o f budgetary resource flows, appropriate incentives and managerial discretion for department and project managers, and periodic evaluations o f the effectiveness o f government programs. An earlier submission o f the draft budget to the legislature can help bring budget approval closer to the start o f the fiscal year, facilitating budget execution. A review o f budget execution processes can help identify and address current weaknesses. Together with improvements in internal control systems, the Government should explore an increase the scope for virement within departmental budgets. The Government should also plan to constitute a standing Expenditure Review Committee to oversee time- bound implementation o f expenditure rationalization recommendations o f the Staff and Expenditure Reform Commission and to undertake rolling annual reviews o f departments to identify unproductive programs and to rationalize and improve efficiency o f existing programs. Box 23: Policy Note on Demand No. 41: School Education, 2003/04 The policy note begins with a clear statement ofobjectives-encompassing inputs and outputs, with anexplicit indicationofbudget for 2003/04 ofRs. 4,203.8 crore, ofwhich Rs.3946 crore i s non-planallocation and allocation. It identifies the "new schemes" under Part 11, includingvari enance items (repairs to office buildings, etc.) and a listing o frecent acco (numberofvacantteacherpositions filled, orders issued for village libraries, counseling systemfor teacher transfers, etc.). The principal thrust ofthe note, however, is coveredby specific chapters for eachtopic- elementaryeducation, secondary andhigher secondaryeducation, teacher training, etc. Underelementary education-the policy note cites the Compulsory EducationAct o f 1994195 and identifies objectives(full enrollment, retention untileighth standard, quality education for learning competence, micro-level decentralizedplanning, and community participation). The structure of thepolicy note suggests an informational purposerather than a document that seeks to make the case for a policy initiative or tojustify a specific funding request. For the most part, it reportsagreedobjectives andindicatesprogramsthat are under way to achieve stated objectiveswith occasionaldiscussionof financing being supplementedby central programs (such as the Education for All program). Source: GoTN's Budget Documents I 75. Strengthening financial accountability. The framework for public financial accountability in Tamil Nadu i s generally sound. Its strengths include the oversight role o f legislature over public finances, regular compilation and timely preparation o f monthly accounts and presentation o f annual financial statements (usually within six months after close o f accounts), and the constitutionally guaranteed independence and broad mandate of the Comptroller & Auditor General. Nevertheless, several areas need strengthening and enforcing to make the public financial accountability system effective and to support the objectives o f the Government's medium-term fiscal and governance reform program. 76. The need for reform i s particularly evident in the area o f budget execution procedures, including the weaknesses in internal controls and the need to eliminate or reduce reliance on Personal Deposit Accounts in the Public Accounts, which distort expenditure and the fiscal deficit. It i s also necessary to modernize the existing computerized treasury systems with upgrading and networking, to improve the quality o f internal audits, and to have more effective legislative oversight and timely responses and follow-up to audit observations. 77. The Government o f Tamil Nadu has started classifying and reporting details o f guarantees in the budget document with a risk rating o f the guarantees. A committee headed by the Chief Secretary was formed to review and discuss the status o f responses to audit observations inbiyearly meetings. 78. The Government o f Tamil Nadu has outlined an agenda for further strengthening financial management, and has prioritized the following actions from the year 2004/05 onwards. 0 Budget execution. The Government intends to review budget execution procedures to identify systemic constraints to effective execution, and to define and implement appropriate remedies. 0 Internal control. The Government intends to address and strengthen certain basic financial management and internal controls that could affect the reliability o f fiscal and financial information, improve the overall internal control environment, and reduce the risk o f misuse o f public funds. Proposed actions include takmg stock o f and formulating rules for write back, opening, and validity o f the Personal Deposit Accounts inthe Public Accounts. The Government also intends to develop measures to address key internal control issues such as reconciliation o f accounts, reconciliation o f loans and advances, timely submission o f utilization certificates, and incentives for compliance. 0 Treasuiy Plans are to be drawn up and implemented to upgrade and network the computerized setup for the Treasury (including departments under the letter o f credit system), and develop a financial management information system for departments. The plan would also address the need for extending computerization to drawing and disbursement offices to enable computerized bill preparation, recording, and control over commitments. 0 Internal Audit. The Govemment o f Tamil Nadu would create a workmg group to review the scope, coverage, and focus o f existing internal audit function, with a view to moving toward a "risk-based" audit approach and to implementing the recommendations o f the working group on a pilot basis. 0 External uudit and legislative oversight. To make the proceedings o fthe committee headedby the Chief Secretary more effective, a database o f all the audit observations would be prepared to monitor and improve the responsiveness to the audit observations. One senior official within the finance department would be responsible for maintaining the database and following up on the audit responses. 24 Initial Outcome of Fiscal Reform 79. This section reviews the initial outcome o f the fiscal reform program. The projected adjustment path as prescribed by the MTFP i s summarized in the next section, along with the implications to the adjustment o f the recent reform reversals (para 31). 80. Revenue performance. Tamil Nadu already has one o f the highest own tax/GSDP ratios in India but the ratio had fallen to less than the level of 10% achieved inthe early 1990s. The Government made significant efforts to increase the tax-to-GSDP ratio from 8.8% in2001102 to 9.4% in 2003104. Buoyancy insales tax revenue was restored, with near 14.5% average growth in2002/03 and 2003/04. The state's own annual incremental revenue almost trebled from Rs.538 crore in 2001102 to Rs.1,561 crore in 2002/03 and Rs. 1,603 crore in2003/04. 81. Expenditure composition. The composition o f recurrent expenditure improved, with a significant narrowing o f the gap between revenue expenditure and revenue receipts. Most notably, salaries and pensions as share o f the state's own tax revenue was reduced from a peak o f 100% in 1999100to 71% in 2003104, and as a share o f revenue expenditure, reduced from 56% to 45% over the same period. The food subsidy was reduced from a high o f Rs. 1,540 crore (7.3% o f revenue expenditure) in 2000101 to Rs.800 crore (3.2% o f revenue expenditure) in 2003104. Non-wage O&M as a share o f revenue expenditure declined from 9.3% in 1999/00 to 8% in 2001102, but rose back up to 9.9% in 2003104. Tamil Nadu's outstanding small savings debt stock as o f March 31,2002, with interest rates above 13% was Rs.4,400 crore, or about 12% o f debt stock. Over 2002103 and 2003104, G o T N swapped Rs. 3,100 crore o f small savings debt under the Go1debt swap scheme. The remaining small savings debt stock has been swapped in 2004/05. Annual interest savings will be over Rs. 200 crore. Consequently, interest expenditure has held steady at 20% o f revenue receipts in 2002103 and 2003/04. In addition, GoTN repaid about Rs. 700 crore to NABARDand about Rs. 500 crore inoff budget borrowing in2004105. 82. Budget deficit improves. The impact o f the fiscal adjustment program has been impressive. While the revenue (current) deficit declined from 2.1% o f Gross State Domestic Product (GSDP) in 2000/01 to 0.9% o f GSDP in 2003104 and 2004/05(RE), the fiscal deficit declined from 4% o f GSDP to 2.4% o f GSDP in 2003104 but has risen to 2.9% in 2004/05(RE). The state also achieved a primary surplus of 0.3% o f GSDP in 2003/04 as compared to a deficit of -2.5% of GSDP in 1999100. But an attempt to boost capital outlay by almost 22% over budgeted estimates in 2004/05(RE) will turn the primary surplus o f 2003104 to a small deficit o f 0.3% in 2004/05(RE). It remains to be seen whether the state i s able to spendas muchby the fiscal year end as the higher outlay i s unprecedented. 83. Consolidated fiscal deficit performance. A key objective o f fiscal adjustment was cleaning up of accumulated arrears from prior years. A large amount o f arrears, Rs. 3,062 crore equaling to 2% o f GSDP, was cleared in 2002/03, including Rs.1,100 crore arrears from 2001/02, and the securitization o f Rs.1,962 crore o f dues to central electricity utilities by the Tamil Nadu Electricity Board. There are pension arrears o f Rs. 1,000 crore from 1999100 when the previous Government postponed these payments for five years due to a liquidity crisis. These arrears are included inthe MTFP for clearance by paying Rs. 2,500 crore, Rs.300 crore and Rs.450 crore over three years from 2003/04 to 2005/06 although their actual clearance can take a little longer. 84. Despite clearing up the arrears, the consolidated fiscal deficit was reduced from a peak o f 6.7% o f GSDP in 1999/00 to 4.8% in 2002103 (Table 2.1)." The close to two percentage point reduction from The consolidatedfiscal deficit o f 5.8% in2000101 and 5.2% in2001102 underestimated real levels owing to accumulation o f (non-pension) arrears: Rs.2, 345 crore (1.7% of GSDP) in2000101 and Rs. 3,062 crore (2% of GSDP) in2001102. 25 1999/00 to 2002/03 was largely attributed to an increase in the ratio o f the state's own tax revenue to GSDP (from 8.6% in 1999100to 9.3% in2002/03), and a reduction inthe ratio o f salaries to GSDP (from 6.5% in 1999100 to 5.2% in 2002/03). Unfortunately, capital outlay and net lending suffered a reduction equaling to 0.4% o f GSDP (due largely to a lack of financing and implementation capacity). The consolidated fiscal deficit is estimated to have decreased to about 3.8% of GSDP in 2003/04 based on estimates for TNEB as against the MTFP target o f 4.8% o f GSDP for the year. Table 2.1: Primary,Revenue,Fiscaland ConsolidatedDeficits as a Percent of GSDP 1997198 1998/99 1999/00 2000/01 2001/02 2002/03 2003/04 Primary Deficit 0.6% 2.3% 2.5% 1.8% 1.1% 1.9% -0.3% Revenue Deficit 1.1% 2.6% 2.8% 2.1% 1.7% 3.0% 0.9% Non Power Deficit (1) 1.4% 4.0% 5.1% 4.1% 3.2% 3.1% 2.2% Budgetary Supportto Power (2) 0.9% 0.2% -0.4% -0.1% 0.2% 1.4% 0.2% Budgetary Fiscal Deficit ( l t 2 ) 2.3% 4.1% 4.6% 4.0% 3.5% 4.5% 2.4% Power Sector FinancingRequirement (3) 0.8% 1.2% 1.6% 1.7% 2.0% 1.7% 1.4% Consolidated Fiscal Deficit (1+3) 2.2% 5.2% 6.7% 5.8% 5.2% 4.8% 3.8% Source:GoTNs BudgetdocumentsandTNEB's accounts Note: Deficits in 2000/01 and 2001102 were lower due to accumulation ofarrears. Data for 2002103 includes clearance of arrears equal to 2% ofGSDP. Pensionarrears in 1999100are included for clearance in 2003104,2004105 and 2005106,respectively. 85. The financial performance o f the Tamil Nadu Electricity Board improved during the period 2001102 to 2003/04. TNEB's EBIDTA i s estimated to have decreased from negative Rs. 1,207 crore in 2001/02 to negative Rs.537 crore in 2002/03. The net loss before subsidy i s estimated to have been reduced from Rs. 1,854 crore to Rs. 1,253 crore over the same period. The financial performance o f the state transport units (STUs) also improved, with net loss reduced by 98.6% between 1999/00 and 2002/03.12 But failure to revise transport fares since December 2001 has meant that the momentum o f improvement in financial performance has been lost. Consequently, the STUs net loss increased from Rs. 4 crore at the end o f 2002/03 to Rs. 32 crore at the end of 2003/04(pre-audit). 86. Guarantees outstanding were 6% o f GSDP in 2003/04, below the ceiling o f 10% o f GSDP (un- weighted guarantees) set by the Fiscal Responsibility Act (also lower than, for example, Andhra Pradesh at 10%). The Government for the first time classified guarantees under five risk categories (from very highriskto nilrisk) as per the guidelines issuedby the Reserve Bank o f India, and made the information public via the 2003/04 budget. The risk-weighted guarantees (Rs. 3,362 crore) amounted to about 2% o f GSDP in 2003/04.13 A guarantee redemption fund along the lines recommended by the Reserve Bank o f India has been established. The Govemment also intends to institutionalize the process o f evaluating requests for guarantees. 87. The GoTN signed up to the Fiscal Reforms Facility o f Government o f India in 2003. As per the Memorandum o f Understanding, GoTN was required to achieve a Revenue Deficit to Revenue Receipts target o f 17.4% in 2003104. GoTN instead has achieved a major improvement over the target by achieving a ratio o f 6.5%. The Twelfth Finance Commission (TFC) has futed Tamil Nadu's share inthe total divisible pool o f central taxes at 5.305% as opposed to the prevailing 5.385%, a marginal decrease. But states' share inthe centre's divisible tax pool has been increased from 29.5% to 30.5%, keeping the effective share o f Tamil Nadu unchanged at 1.6% o f central taxes during 2005/06-2009/10. The total l 2The finances o fthe state transport units have not been incorporated into the consolidated fiscal deficit. The Bank's work on states` fiscal reform has focused so far o n incorporating the finances o f the power sector into the consolidated fiscal deficit. l3 The risk weights used are as follows: 100%risk weight assigned to the very high risk category, 75% to the high riskcategory, 50%to the mediumriskcategory, and 25% to the lowriskcategory. The nilrisk categoryusedbythe govemment i s treated as off-budget borrowing. 26 devolution o f central taxes to Tamil Nadu over the five year period i s estimated by the TFC at Rs. 32,553 crore. The TFC has done away with normal central loan assistance for state plans in favor o f market borrowings. Tamil Nadu is not affected by this change. The TFC has also recommended debt relief to the states in the form o f restructuring o f all central loans with state governments' as o f March 31, 2004 outstanding as o f March 31St,2005. The loans will be consolidated and rescheduled at 7.5% interest rate repayable over twenty years. This has been made conditional on states' enacting Fiscal Responsibility Legislation, which Tamil Nadu government has already enacted malung it eligible straightway. As a result, Rs. 6,872 crore o f outstanding central loans on Tamil Nadu government's books will be restructured. The interest gain i s estimated at Rs. 1,195 crore in Tamil Nadu's case over the period 2005/10. The TFC has also recommended debt write-off linked to reduction in the revenue deficit o f the state government. Under the scheme, a certain proportion o f repayment o f rescheduled debt will be written off by Government o f India over the period 2005106 to 2009/10. The quantum o f write-off i s linked to the absolute amount o f reduction in the revenue deficit each year with the ultimate objective o f eliminating the revenue deficit by 2008/09. Tamil Nadu can benefit to the extent o f Rs. 1,718 crore in debt write-offs under the scheme. Tamil Nadu also gets Rs. 1,214 crore in grants for maintenance o f roads and bridges, Rs. 242 crore for maintenance o f public buildings,Rs. 30 crore for forests, Rs. 40 crore for Heritage conservation, Rs. 250 crore for development o f urban areas and Rs. 50 crore for sea erosion over 2005/06 to 2009/10. 88. GoTN's MTFP has been revised along with the 2005/06 budget and accelerates the fiscal adjustment path when compared to the first MTFP. The revised MTFP builds in the TFC's award conservatively as opposed to the actual award thereby providing a revenue cushion. The state benefits from TFC's debt restructuring and debt write-offs while it i s not affected by the abolition o f central lending in support o f state plans. However, to take advantage o f the debt write-off the state has to stay on track to eliminate the revenue deficit by 2008/09 which i s also the state's revised MTFP target. If the GoTN maintains its current rate o f progress, it i s well poised to take full advantage o f the TFC's recommendations. The costs o f policy reversals o f 2003/04 have thus been absorbed in 2005/06 but pose an underlyingmedium term fiscal threat unless effectively addressed. Medium-TermAdjustment Path 89. Consolidated fiscal deficit. The medium-term adjustment path under the first MTFP (2003104- 2008/09), which was tabled in the state legislature on February 11, 2004, was predicated on maintaining an increasing own revenue effort progressing from 10.2% o f GSDP in 2002/03 to 10.4% in 2008/09- with the state's own tax revenue improving from 9.3% o f GSDP in 2002/03 to 9.8% in 2008/09-and further reorienting expenditure from salaries, pensions, and subsidies to non-wage O&M and capital investments, while stabilizing the consolidated fiscal deficit (see Table 2.2 below) to achieve a targeted real GSDP growth rate o f 6% by 2008/09.14 90. The reversal o f some reforms-PDS, bus travel concessions and electricity tariff after national elections inMay have resulted inmidyear expenditure o f Rs. 1,000 crore. Additional expenditure o f Rs. 650 crore was provided for in supplementary budgets increasing expenditure in 2004/05 to about Rs. 1,650 crore over the budgeted estimates (about 5% o f projected expenditure in 2004105). But lower expenditure under salaries and pensions o f Rs. 1,500 crore in the 2004/05(RE) as compared to the budget l4The MTFPwas drawn up by the Government using 2003104 (revised estimates) as the base. Subsequently, higher Go1devolution inMarch2004 and savings under salaries and pensions and lower capital outlay resulted inthe state exceeding the MTFP projections for 2003104.With revised estimates for 2004/05 available to government and taking into account the impact o fpolicy changes, the TNEB's accounts for 2003104 and 2004105, the salary cost o f 15,500 new hires, the Twelfth Finance Commission's award, revised GSDP growth projections etc. the first M T F P has beenupdated along with the budget for fiscal 2005106. However, it is usefulto look in detail at the first MTFP as this was the state's first effort at fiscal projections and formed the basis for budget 2004105. 27 estimates and stronger than projected revenue growth has meant that the fiscal deficit in 2004/05(RE) i s projected to be lower at Rs. 5,447 crore (3% o f GSDP) as compared to the budgeted Rs. 6,921 crore (3.8% o f GSDP). The lower fiscal deficit also builds in higher capital outlay and non wage operations and maintenance expenditure o f Rs. 1,100 crore as compared to the budget.15 As it stands, the increase in subsidy expenditure implies little threat to achieving the MTFP targets in the near term. But an opportunity i s being lost of trying to correct resource misallocation and thereby decreasing underlying fiscal risks on the expenditure side. Table 2.2: Primary, Revenue, Fiscal and Consolidated Deficits as a Percent of GSDP Projected UnderTamil Nadu's MTFP (February, 2004) 2002/03 2003/04* 2004/05 2005/06 2006/07 2007/08 2008/09 PrimaryDeficit 1.9% 1.3% 0.8% 0.3% -0.3% -0.5% -0.9% RevenueDeficit 3.0% 2.2% 1.9% 1.5% 0.7% 0.4% 0.0% Non Power Deficit (1) 3.1% 3.8% 3.6% 3.2% 2.6% 2.4% 2.1% Budgetary Support to Power (2) 1.4% 0.3% 0.1% 0.1% 0.1% 0.1% 0.1% Budgetary Fiscal Deficit (1+2) 4.5% 4.1% 3.7% 3.3% 2.8% 2.5% 2.1% Power Sector FinancingRequirement(3) 1.7% 1.O% 0.8% 0.6% 0.4% 0.1% 0.0% ConsolidatedFiscal Deficit (1+3) 4.8% 4.8% 4.4% 3.8% 3.0% 2.5% 2.1% Source: GoTNs MTFP, Budget Speech 2004105. Note: Data for 2002103 are actuals, including clearance o f arrears equal to 2% o f GSDP. * 2003104 actuals have improved dramatically over the MTFP target Deficits for 2003104,2004105, and 2005106 include clearance of pension arrears from 1999100. 91. Revenue performance. The ratio o f revenue to GSDP was projected to increase from 13.3% in 2002/03 to 13.7% by 2007/08 inthe first MTFP. The scope for increase inthe tax ratio i s constrained: by the already hightax effort in Tamil Nadu; the Constitutional restriction on state taxes to certain types and activities (particularly the state's inability in taxing the bulk o f the fast growing services sector), the secular decline in Tamil Nadu's share in shared taxes devolved by the central government, the relatively slower GSDP growth in Tamil Nadu in recent times and the perceived political difficulty o f substantial increases inuser charges. 92. Expenditure composition. The share o f non-wage O&M and capital outlays and net lending to GSDP i s projected to rise from 2.9% in 2002/03 to 3.6% in 2008/09 in the first MTFP, owing largely to the projected decline inthe share o f salaries (from 5.2% o f GSDP to 4.3%) and food subsidies (from 0.8% o f GSDP to 0.3%) over the same period. However, reversal in policy reforms pertaining to subsidies (para.3 1) may make expenditure adjustment relatively slow. It i s not certain now whether the GoTN can undertake higher non-wage O&M and capital outlay without raising the fiscal deficit given the fiscal cost o f the new policy choices. The decline in the share o f salaries i s to come from a combination o f two factors: the net attrition o f 2.8% per year during the MTFP period (which are explained by the projected retirement patterns and hiring freeze) and the slower growth inthe cost o f living indexationo f wages (i.e., dearness allowances). 93. Priority development expenditure. The first MTFP projected an increase in development expenditure (capital outlays and non-wage O&M) inpriority infrastructure and social sectors (roads, rural water supply and sanitation, irrigation, elementary education (ages 6-14), nutrition and health). However, l5Four broad sets of factors have additionally helpedthe state meet the challenge o f the additional expenditure: (i) salaries and pensions have remained virtually flat innominal terms in2002103 and 2003104 (ii) government the expects conservatively to realize Rs. 1,500 crore o f savings under salaries and pensions expenditure as compared to the budget in2004105, (iii) interest expenditure savings consequent to debt restructuring in2004105 and (iv) revenues have been growing well duringthe fiscal year 2004105 exceeding the Budget projections ( 15% over 2003104 as opposed to annual 3% inthe MTFP). 28 the fiscal costs o f the policy reversals would shrinkthe resource space originally envisioned inthe MTFP to make the desired expenditure adjustment. 94. Since about 80% o f total expenditurei s inflexible innature (salaries, pensions, interest, subsidies and transfers), reform will have to target these heads o f expenditure ifresources are to be found for non- wage O&M and capital outlay without expanding the fiscal deficit. The long-term economic growth consequences o f poor expenditure composition can be costly. The ability to increase social expenditure in critical areas such as education, health, water supply and sanitation, and nutrition may be affected. To put the Rs. 1,100 crore expenditure on annual power subsidy inperspective: the state spends about Rs. 1,400 crore only (4% o f total expenditure) on the entire health sector and Rs. 750 crore (3% o f total expenditure) on water supply and sanitation. The higher subsidy burden therefore represents a lost opportunity to improve social outcomes. 95. Pension reform (para 52) has slowed growth o f pension liabilities-reducing the implicit pension debt by 7% o f GSDP. However, it i s not realistic to expect reduction inpension expenditure in the short to medium term. This is mainly due to the long-term nature o f pension policies, the acquired rights o f existing employees, the aging civil service which, measuredby per hundredpopulation, i s larger than all other Indian states except Punjab, and the need for the Government to contribute to the new defined contribution scheme. 96. Revised MTFP. The MTFP has been revised to reflect changes in policy, TFC's award, changes in underlying economic growth scenario and builds on the 2004/05(RE). The revenue growth assumptions are conservative. For instance in 2005106, tax devolution to the state from the centre has been budgetedby the centre at Rs. 5,041 crore as compared to Rs.4,407 crore inthe first MTFP, a gain o f Rs. 634 crore if realized. The GoTN in its 2005106 budget has gone along with a more conservative assumption o f Rs. 4,672 crore, thus providing an inbuilt revenue cushion. The buoyancy o f Sales tax i s assumed at 1.05 from 2006107 onwards; state excise growth at 3.5% per annum, vehicles tax at 8% per annum and stamp duty at 5% per annum. The revised nominal GSDP growth assumptions although higher than the first MTFP i s still an annual average 10.4 %. The revisedMTFP targets revenue surplus in2008109 as against a marginal revenue deficit inthe first MTFP. The fiscal deficit is to be reducedto 3% o f GSDP by 2005/06 as against the TFC's requirement of doing so by 2008/09. The revised fiscal targets are shown inTable 2.3. Table 2.3: Primary, Revenue, Fiscal and Consolidated Deficit as a Percent of GSDP Under Tamil Nadu's revised MTFP (March, 2005 ) 2003/04* 2004/05(RE) 2005/06(BE) 2006/07 2007/08 2008/09 Primary Deficit 0.3 -0.3 -0.5 -0.2 0.1 0.4 Revenue Deficit -0.9 -0.9 -0.7 -0.6 -0.3 0.o FiscalDeficit -2.4 -2.9 -3.0 -2.6 -2.2 -1.9 ConsolidatedFiscalDeficit -3.8 -3.9 -4.2 -3.5 -2.7 -2.3 Source: GoTNs MTFP, Budget Speech 2005/06. * Accounts,positive sign indicates surplus Fiscal Sustainability and Risks 97. If the fiscal reform and MTFP are broadly on track, Tamil Nadu's debt stock is expected to stabilize around 31% of GSDP in 2005/06, a level below that inmany other Indian states. However, due to fiscal cost of recent policy reversals, the debt to GSDP ratio may increase from 31% o f GSDP in 2004105 to 32.3% o f GSDP by 2008109. 98. Tamil Nadu's long-term fiscal sustainability will depend critically on two factors: The first i s the evolution o f key national macroeconomic variables-real interest rates on government borrowing, 29 inflation rate, and actual devolution o f the center's shared taxes. The second factor consists o f the evolution o f two key variables-the state's economic growth and the primary deficit-that will depend largely on the policies and reforms o f the state government. The central government can still influence these two key variables through for example: tax devolution policy, the Pay Commission, and policies o f a concurrent nature affecting economic growth (e.g., labor market reform and bankruptcy procedures). To stabilize the debt-to-GSDP ratio over the long term, the government will need to implement reform measures that stimulate economic growth, eliminate primary deficit, or lower the effective interest cost o f borrowing-ar all. 99. There are significant risks to fiscal adjustment across Indian states; Tamil Nadu i s no exception. These risks are: Political resistance to adjustment. Correction o f the distortions and fiscal excesses o f several decades entails large short-term costs. These affect many vested interests and are often met with strong resistance. The resistance typically intensifies near and during elections. Prior to the national elections in April-May 2004, the political leadership had provided strong support for reform. However, after the electoral loss some critical reforms were rolledback. A key challenge in fiscal adjustment is the perceived political difficulty o f increasing user charges. This is amply illustrated by the difficulty o f pricing power supply to agnculture. Providing increasing budgetary support to would derail fiscal recovery. Financing the deficit through arrears or guaranteed-backed borrowing would increase the government's contingent liabilities. Unexpected macroeconomic shocks could threaten Tamil Nadu's fiscal sustainability. India's large fiscal imbalances could pose a threat to sustained economic growth. Slower growth and high fiscal deficits may translate into higher borrowing requirements but also put pressure on interest rates on government borrowing. This would negatively affect the ongoing debt restructuring efforts at the state level, hence the trajectory o f debt sustainability. Since interest and real growth rates tend to be negatively correlated, it i s very likely that if interest rates start rising, economic growth will decline, resulting in a rise in the debt-to-GSDP ratio unless fiscal policy i s adjusted. For instance debt dynamics modeling, the combination o f rising nominal interest rates (say between 11% and 14%) and economic slowdown (to 3%) imply that the government will have to run surpluses in the range o f 0.9-1.9% o f GSDP in order to avoid increasing the debt-to-GSDP ratio beyond 35%.16 0 A decline in central government revenue transfer poses another risk. Successive federal Finance Commissions have reduced the percentage share o f Tamil Nadu in the pool o f net shareable central taxes, and the contribution o f the share o f central taxes to Tamil Nadu's revenue declined from 21% in 1992/93 to 15% in 2002/03. The TFC's award will be a determinant o f the pace o f fiscal adjustment at the state level. Central transfers to states (both as share o f revenue and GDP) have fallen over time because o f decrease in the revenue to GDP ratio o f the Go1 (Box 2.4). Further tax sharing i s necessary to reduce vertical imbalances between expenditure responsibilities o f states and their revenue powers and to address the revenue concerns o f relatively better-off states. For example, the Go1can assign the right to states to tax a larger share o f services and raise the constitutional ceiling on the professional tax. If and when the central government reduces or abolishes the Central Sales Tax, Tamil Nadu, as an exporting state, will lose tax revenue, and it i s important that it have other sources available to it as compensation. 16Details o f the model are presented inthe report Tamil Nadu: FiscalReformand Sustainability, World Bank (2004). 30 Moreover, introduction o f VAT (announced for April 1, 2005) should be on the basis o f floor rather than harmonizedrates, so that states like Tamil Nadu do not lose revenue as a result. Any shortfall in revenue due to VAT introduction could jeopardize Tamil Nadu' s medium-term fiscal Box 2.4: Central Transfers to Stateshave fallen As Figure 2.2 shows, centraltransfers have fallen over the last two decades largely because Go1revenue has fallen as a percentage o f GDP, and to a lesser extent because there has been a decline ingrants to the states as a percentage o f central (gross) revenue. Inthe last few years, stronger revenue growth, andanincreasedshare going to the states have helpedreverse the long-term decline inGo1transfers to states. However, transfers are yet to reach the 5% o f GDP level last seeninthe early nineties. Figure 2.2: Trends in Go1revenues and transfers to states 55.0% g 52.5% 3 15% 14% a 50.0% I 13% 47.5% 12% g f e 45.0% 11% 2 Transfers from Go1 to : 42.5% 10% 0 states (LHS) 9% 5 40.0% C 8% 1 37.5% 7% $' 35.0% 6% Source: State Fiscal Reforms inIndia, World Bank (2004) 100. Extemal shocks are a major source o f risk to fiscal adjustment. Tamil Nadu's agriculture i s vulnerable to periodic droughts due to its dependency on rainfall. More frequent than inthe recent past, three annual droughts including the unprecedented century's worst statewide drought in 2002, led to an annual average of -3.9% growth during 1999100-2002/03 compared with an annual average o f 4.5% in the previous nine years. The droughts have greatly contributed to the slowdown in economic growth as well as the financial deterioration o f the power sector in 2001 and the slower recovery in 2002, notwithstanding tariff adjustments. Droughtts) during the medium-term adjustment period could seriously affect economic growth (and hence tax collection) and the TNEB. 31 111. IMPROVINGINVESTMENTCLIMATE FORMANUFACTURINGAND SERVICES 101. Fiscal reform must be complemented with a strong program to improve investment climate for accelerating economic growth and meeting the poverty reduction objective. The slowdown in economic growth in Tamil Nadu since the late 1990s and the structural impediments to faster economic growth would affect the pace of poverty reduction. The debt dynamics analysis underscores the importance o f accelerating economic growth to achieve fiscal correction and sustainability. Faster economic growth positively influences not only debt sustainability but also employment and income generation, facilitating a larger distribution o f reform gains. 102. Economic growth i s a key driver for sustaining and accelerating the pace o f poverty reduction and the attainment of MDGs. Accelerating economic growth i s the foundation stone o f anti-poverty policies worldwide. A dynamic economy, growing strongly, i s a powerful force for creating new and better employment opportunities for poor people, enabling empowerment, and reducing vulnerability. Most o f the reduction in poverty in the recent period in India has been a result o f the increase in average consumption driven by economic growth (Deaton and Dreze, 2002). InIndia, policies that foster overall economic growth has the greatest potential for reducingpoverty further (Ferro, Stern, et. al, 2003). 103. Cross-country evidence has demonstrated a strong link between investment climate and growth. There could be considerable growth gains from improvement in investment climate in Tamil Nadu. Investment climate influences the expected returns and flow o f foreign and domestic investment to a country or a location. Inaddition to macroeconomic policy, political stability and national policy towards foreign trade and investment, investment climate comprises o f two critical factors: efficacy and transparency o f regulatory framework for factor markets (labor, capital and land), for taxation policy and administration as well as for starting or exiting a business; and quality and quantity o f available physical and financial infrastructure. Findings from the investment climate surveys in Tamil Nadu suggest that cumbersome and excessive regulation and infrastructure bottlenecks are major or serious constraints to growth.17 Accelerating economic growth will require sound policy, institutions and infrastructure development to support private sector development. 104. Priority reforms concern labor market flexibility, a more responsive urban land supply system, more efficient tax policy and administration, streamlining regulations over entry, exit and operation, power sector reform and scaling up PPP for sustainable infrastructure development. Several important issues are exclusively or largely within the purview o f the central government: labor reforms, the introduction o f VAT, exit policy and b a n h p t c y procedures, and key infrastructure such as national highways, international air markets, major ports and rails systems. Within the federal framework, Tamil Nadu can explore reform opportunities. RemovingRegulatoryBurdens 105. The regulatory framework is broadly understood to include the following three areas: factor market regulations, i.e., regulations of labor, capital, and land markets; tax and customs administration; l7 41% o f respondents ina World BanWCII survey identified infrastructure as a severe bottleneck to improving the investment climate as compared to say 25% inGujarat. 47% felt power was a severe bottleneck, 43% felt transport was a bottleneck (second highest after Karnataka's 50%). Senior management inthe survey reported spending 13% o ftheir time dealing with regulations as opposed to say Haryana 10%.Tamil Nadu's manufacturing establishments reported an average o f 11official inspections a year as compared to 5 inMaharashtra and 6 inKarnataka. 14% of respondents (second highest after Gujarat's 21%) inTamil Nadu felt constrained by overstaffing. 42% respondents reported corruption as a growth bottleneck better than Kamataka's 65% but worse than Andhra Pradesh's 10%. Source: India Investment Climate Assessment ,World Bank November 2004. 32 and regulations o f entry, exit and operation through regulationrequirements and bankruptcy laws. Tamil Nadu has made reform efforts to improve the regulatory environment for the private sector such as the entry regulation for larger investment projects and regulation and streamlining regulations over compliance with labor regulations, but the regulatory environment generally continues to be complex. Many o f the issues such as labor regulations, indirect tax, exit and bankruptcy procedures are largely withinthe purview o fthe central government. 106. Labor market rigidity. Labor market restriction on hiring and retrenching workers i s one o f the greatest challenges of doing business in India, according to the Global Competitiveness Report-India ranks 73rd o f 75 countries. Rigid labor regulations have prevented Tamil Nadu from unleashing its full potential in labor productivity. Tamil Nadu i s known for its good industrial relations and its highly educated, hard working and a disciplinedlabor force. 107. There are three main issues with labor legislations. The national Contract Labor Act 1970 restricts the hiring of contract labor. Any firm employing more than 100 employees must seek official permission for retrenchment or closure based on the national Industrial Disputes Act o f 1947. The regulatory maze i s complex, leading to high compliance cost and rent-seeking. There are 23 Union Acts and seven State Acts and Rules which are enforced by the Labor Department inTamil Nadu. For each o f these subjects there are different enactments by the center as well as implementing rules by the state. Many regulations are excessive and outdated (e.g., no overlapping o f shifts, capping o f overtime, official permissionrequired for worlung on Sunday or holidays, specified number o f food cafeterias, and over 60 types o f minimumwages). 108. Rigid labor regulations deter greater employment generation. Stringent labor institutions tend to benefit a narrow segment o f the population comprising the organized and unionized labor, intermediaries in the labor market, and corrupt officials, at the expense of a much larger segment o f the labor force comprising the unemployed, those employed in the unorganized sector, andor agncultural laborers who are seelungjobs inthe organized industrial sector. 109. Labor regulations are largely within the purview o f the central government. Nonetheless, within the federal framework, Tamil Nadu can explore ways to rationalize and consolidate implementing rules concerning the legal framework governing labor and statutory compliance requirements to create elbow room for contractual labor relationship and for easing threshold for retrenchment. The experience o f Maharashtra and Andhra Pradesh in attempting a more flexible interpretation o f the central regulations may be o frelevance to Tamil Nadu. 110. Constraints in finance. The issues o f access to and cost o f finance are at the purview o f the central government, thus affecting all states. The key obstacles are high interest costs, collateral requirements, and burdensome paperwork. Recent downward trend in interest rates has been a factor responsible for revival o f industrial growth. India's Small and Medium Enterprises (SME) sector still faces a relatively highcost of capital, owing to market andpolicy government failures. There is an adverse selection inthe credit appraisal process for SMEs, and interest rate premium for the higher transactions costs in dealing with small borrowers, the lack o f sufficient credit information on these firms, their frequent inability to provide collateral, problems incollecting on collateral (typically landproperty) from small borrowers due to the lack o f updated landproperty records and the uncertainty surrounding land ownership, resulting in higher costs o f default and contract enforcement. 111. Urban land market constraints. Urban land markets play a critical role in urban infrastructure. They provide the physical space for industrial, commercial and residential development as well as providing rights o f ways for critical infrastructure systems such as roads, transit, water and sanitation and power networks. Significant and growing demand for urban land requires an efficient land delivery system, effective land zoning and a regulatory process for infrastructure and housing development review 33 and permission. Rapid urbanization and demographic growth-from 19 million urban population to 27 million inthe 1990s inTamil Nadu-generate significant demands for urban land (Table 3.1). Inorder for cities to grow, either agncultural land at the periphery or vacant and underutilized land in urban areas must be developed. Table 3.1 :Prqjected urban population and employment growth in three cities Annual AnnualProjected Annual Projected Projected Annual UrbanLand IndustrialLand Metropolitan Population Employment Requirements Requirements Area (LPA) growth growth hectares hectares Chennai 1991-2011 180,000 24,400 1,900 250 Coimbatore (1991-2001) 46,000 17,600 600 160 Tirupur (2001-2021) 16,800 17,000 420 200 Note: Data from the master plans o f the three cities. 112. The initial assessment found the following systemic weaknesses in urban land market in Tamil Nadu: Master plan designations in the absence o f complementary incentives and measures make the supply o f land for development inefficient; land acquisition and project development i s complex, time consuming and expensive; obtaining permission and license for building construction industryi s complex and time consuming; floor space Indices (FSI) are overly restrictive; over-designed subdivision regulations exacerbate the effects o f low FSI; rent control, though not enforced for all buildings, also limits supply by discouraging owners from redeveloping properties to more intensive uses; taxes on land transfers are high comparing with international practices; and considerable land across cities i s held by government agencies immobilized. These systemic weaknesses have led to more expensive facilities and housingthan necessary, promoting urban sprawl, and ledto 1.3% lost GDP per year for India. 113. Urban land issues are within the purview o f the state govemment. It i s important to rationalize regulations on urban land zoning and development controls, and project approval and land acquisition processes, and develop a more effective planning and management system to facilitate infrastructure development. As a first step to prepare for reforms, the Government o f Tamil Nadu i s undertalung a comprehensive urban land audit in Chennai, in collaboration with the private sector and an academic institution and planned to extend the audit to secondary cities. 114. Constraints in the sales tax system. While the Tamil Nadu sales tax system generally i s buoyant and the state has one o f the highest own tax effort, it has a number o f features which have a negative impact on the investment climate and long-term growth. The existing sales tax regime, the main source o f Tamil Nadu's own revenues, i s inefficient with multiple rates, non-standard classification of goods, and concentration of taxation on certain sectors. It has a relatively high tax burden on inputs, with the effective tax rate on inputs at 6.7% and taxation on inputs accounting far 32% o f the total collection. Figure 3.1 depicts effective tax rates in 2002/03 for select commodities. The complex structure induces high compliance costs, while the frequent ad-hoc changes in the tax regime generate uncertainty for businesses. 34 120. An important entry deterrent has been the Small-scale IndustryReservation (SSIR) policy by the central govemment. This policy discourages economies o f scale and greater efficiencies-by inhibiting small firms from investing beyond the stipulated limits, expanding their operations in the domestic market, and then moving into exports. Although some o f the important items have been de-reserved (e.g., garments, toys and leather products), SSIR has had significant negative impact over decades on the competitiveness of Indian industries. 121. Despite the remaining influence o f the SSIR, Tamil Nadu can further streamline entry regulations intwo areas: streamlining regulations concerningconstruction andrealestate industriesand extendingthe simplified entry regulation covering large investment projects to smaller projects in every level o f investment. 122. Exit and bankruptcy procedures, both at the purview o f the central govemment, remain outdated and ineffective, leading to inefficiencies and malung industrial restructuring almost impossible. The Amendments to the Companies Act (2002) should improve the bankruptcy framework. The effectiveness of the amendment will depend on the repealing o f the Sick Industries Companies Act and the pace o f labor market reform. ResolvingInfrastructureBottlenecks 123. Infrastructure i s more developed in Tamil Nadu than in many Indian states but compares poorly with other emergingeconomies. Close to 40% o f surveyed managers and about 50% o f exporters inTamil Nadu view infrastructure as a major impediment to investments and growth. The infrastructure constraints are across-the-board including power, transport, ports and water. Substantial investment requirements also arise from rapid urbanization in Tamil Nadu. Box 3.1 reflects the World Bank's own interaction with entrepreneurs inTirupur, India's leading hosiery exporting centre. 124. Power has become a top infrastructure constraint despite the relative efficiency o f the state power utility and having the second largest power market in India. High power tariff to industries and poor quantity and quality o f power supply reduce the competitiveness o f Tamil Nadu's industries. The financial stress o f the TNEB, arising largely from cross subsidy to agriculture (and now the domestic consumer segment also), has increasingly constrained its investment ability to improve the quality o f power supply. Captive generation sets in operation as a share o f total electricity sold in Tamil Nadu has reached 15%, with a statewide average captive plant load factor of 25%. The capital cost o f captive generation sets constitutes about 11% of total fixed assets for small businesses. Like many other states, Tamil Nadu will need to find a political solution to the metering o f agriculture pump sets and reduction o f cross-subsidy to improve the competitiveness o f industryand services. 36 125. On transport, India has no access-controlled expressways linkmg the major economic centers, while for example China has built substantial expressway capacity (over 27,000 kilometers) since the mid-1990s. Poor riding quality and congestion result in truck and bus speeds on Indian highways that average 30-40 kilometers an hour, about half the expected average. Demand for road transport has been Box3.1:InfrastructureBottlenecksFacingTEKIC inTirupur The Tirupur Export Knitwear Industrial Complex (TEKIC) is one of the major industrial estates or clusters in Tirupur. Tirupur has a population of about 420,000, but exportsUS$1billion inknitwear, accounting for about 18%oftotal Indianknitwear exports in2000101. TEKIC has 189 laid out sheds situatedinand around 100 acres of land and 148 industrial units with small and mediuminvestment inoperation. Most firms inthe complex export to US andEuropemarkets. Inthe lastthree years, member firms have exported about Rs.1750 crore of knitwear (close to US$400 million). The complex employs about 10,000 workers. A World Bank team met with a dozen representatives of businesses in the complex inMay 2003. The following infrastructure constraintswere highlightedbythe representatives: Power cuts and fluctuation make it difficult to use precision machinery and equipment which are essential for exportproducts; Roadcongestions aroundthe complex, inTirupur andto the ports. Adding to these are the rigid labor regulations which make it difficult to efficiently adjust workforce to meet seasonalvariations inbusiness demand, while such variations are typical ingarment exports. TEKIC faces huge competitive pressure with the phasing out of quota-based export system under the Multi- Fiber Agreement. Infrastructure investmentsare thus urgently neededto make it possible for TEKIC to prepare for competition. The urgently required infrastructurerequirementsaccordingto the entrepreneurs are: Settingup apower plant to provide reliable quality power supply. Strengtheningand widening the existing road and providing storm water drain Developing a new road connecting Vijayapuram inTirupur (Kangayam road) and Periyapalayamin Tirupur (UttuMculi Road). Building ahigh-level bridge acrossriverNoyyalto interconnectthe above roads. Source: Tamil Nadu :ImprovingInvestmentClimate, World Bank (2004) increasing rapidly in Tamil Nadu with vehicle registrations growing by about 14% annually during the 1990s. However, road network supply and quality have not kept pace with the growing demand, leading to serious network deficiencies in terms o f slow response to growing demand, inadequate road capacity and maintenance, severe road congestion and highrate o f accidents. 126. Tamil Nadu has initiated measures to improve the transport network. The East Coast Highway undertaken by Tamil Nadu Road Development Company, a joint venture between GoTN and Infrastructure Leasing & Financial Services, i s an excellent example o f public private partnerships for rehabilitation and maintenance of roads, and could be applied more widely to upgrade the road network. The provision o f state equity and other financial support such as "viability gap funding" are also methods of leveraging public funds, which GoTN i s considering. A clear regulatory framework for support o f public private partnerships needs to be put inplace which would define the role o f the government and the private sector, lay out the risk sharing principles and also regulate the tariff regime for private roads. An important priority i s to press forward with fiscal reform to create fiscal space for investment in the infrastructure sector. 127. There are complex administrative barriers, hightransaction costs and delays relating to shipping, truckmg, and customs administration o f exports and imports at major ports. The entire cargo transport chain from inland to a European port i s estimated to cost 15% higher, and many days o f delay, than the reform scenario. 37 128. On water supply, unreliability and shortage are a major weakness in Tamil Nadu's physical infrastructure. The problem, however, i s not limited to Tamil Nadu alone. Across India about 54% o f businesses rely on own wells. The problem in Tamil Nadu i s more acute because o f the absolute scarcity o f water resources in the state. Renewable freshwater resources are scarce, owing to high variability o f rainfall and resulting low river flows and periodic drought. Ground water has been overly exploited. Many o f the most important aquifers o f the state have been tapped at an unsustainable rate. Businesses report an average o f 11 days per month o f interruption in water supply from the public line, against the all-India average o f 4 days per month and only about half day per month inMalaysia. The economic cost o f raw water i s high, but water user charges are well below cost recovery. Industrial consumers pay substantially higher tariffto cross subsidize domestic users. 129. Public and private partnership in infrastructure finance and development. Fiscal distress inTamil Nadu (as well as in many other Indian states) i s a major constraint on the public financing o f badly needed infrastructure investment and maintenance. Planned capital outlays and net lending covering all sectors i s about U S 7 5 0 million in 2004/05, or 1.9% o f GSDP. This i s already much higher than the US$300 million in 1997198 (1.2% o f GSDP) before the start o f the fiscal crisis. Assuming the success o f the fiscal adjustment, capital outlays per year are estimated to increase gradually to only about US$1.2 billion, or about 2.1% o f GSDP in 2007/08. This would, however, satisfy only a fraction o f investment demands. 130. Another constraint i s the limitedlocal municipal govemment revenues from user charges, under assessment o f property taxes, and drying up o f institutional financing backed by state guarantees. Table 3.2 presents an assessment o f urban investment resource needs estimated by the Second State Finance Commission for Tamil Nadu's public and private partnerships in infrastructure financing and development are therefore not only a fiscal necessity but also within the broader reform context in India o f creating sustainable financial structures which link liberalizing domestic capital markets with urban infrastructure financing needs. Table 3.2: Sectoral Investment Requirement 2002-2007 Rs. crores Town Local Body Corporations Municipalities Panchayats Total Yo Water Supply 506.2 673.4 1409.4 2589.0 31.9 Sanitation 409.3 391.3 41.7 842.3 10.4 Solid waste mgmt. 116.0 33.8 20.5 170.2 2.1 Storm water drains 747.9 1101.6 684.5 2534.0 31.2 Roads 310.8 204.4 406.5 921.7 11.3 Lighting 43.2 43.6 125.3 212.1 2.6 Others 341.7 231.O 282.9 855.6 10.5 TOTAL 2475.1 2679.0 2970.8 8124.9 100.0 Source: State FinanceCommissionReport 11,2002 131. Tamil Nadu has been at the forefront o f experimenting with public-private partnerships in infrastructure financing and development (Boxl.l). These reforms have shown that private sector participation under appropriate regulatory arrangements would help not only address the problem o f l o w capital outlay owing to fiscal constraints but also highlight the benefits o f increased efficiency in infrastructure financing, delivery, and management. For example, in the East-Coast Highway (1OOkm) project, the GoTN's contribution o f Rs.10 crore leveraged an investment o f Rs.51 crore from the private sector. It will also save the Government more than Rs.lOO crore through savings on future maintenance expenses and ensure sustained O&M spending for the entire 30-year concession period. 38 132. Experiences with implementation have underscored the importance o f the following key factors for a successful public-private partnership pilot: providing selective credit enhancement to Urban Local Bodies and developing financing mechanisms with targeted use o f state government contribution and guarantees and link municipal financing with domestic capital markets; leveraging private equity and debt financing to multiples o f initial public investment; user fees based on improved service delivery and cost recovery with cross subsidies between consumer categories; building in consideration o f operations and maintenance spending when planning a project; and proactive support from the government in inter- departmental co-ordination, close monitoring and trouble shooting; and transparency in bidding and contracting. Inaddition, a supportive political environment, regulatory certainty (for user charge regimes, concessions and contracting out, and dispute resolutions), operational restructuring to improve the functioning o f public institutions, and initial equity participation are important in reassuring private promoters and attracting co-financing from financial institutions. The thrust o f reforms should be on sustaining and enhancing project cash flows, rather than relying on government subsidies andguarantees. 133. With industry and service sectors accounting for over 83% o f GSDP, Tamil Nadu i s among the more rapidly urbanizing states in India, which i s causing growing pressure on urban land and infrastructure. With publiciprivate collaboration, the Government has initiated a comprehensive assessment o f urban land markets and projections o f future land supply requirements in Chennai, the state capital. Such projections will facilitate the development o f an efficient, cost-effective, and financially sustainable urban land delivery system to meet the growing needs for urban infrastructure. The land market audit i s plannedto be extended to selected cities and towns. 134. The Government has plans to issue an Infrastructure Policy Paper and establish an Infrastructure Development Board with membership o f the private sector to implement the gradual scale up o f public- private partnerships. Giventhe intrinsic linkbetween urban land markets and infrastructure development, and based on international experience, pilot projects inurban areas can be initiated to focus on using land value capture to mobilize public finance, structuring partnerships with the private sector in finance and development, using value capture to finance housing projects for the poor, and integrating sustainable environment management with urban landmanagement and infrastructure development. 135. Special economic zones. Special economic zones (SEZs) have been envisioned in India as a scaled-up version o f the export processing zones (EPZs) to overcome the constraints o f poor infrastructure and highregulatory burdens. GoTN has recently unveiled its own special economic zones policy providing broad guidelines with specifics being worked out. International experience o f EPZs and SEZs is mixed, which can provide lessons for the design o f a policy and regulatory framework for SEZs. Unless SEZs can significantly overcome key constraints facing the private sector, SEZs will simply be a physical scaling up o f EPZs while experience o f EPZs in India i s mixed. State-wide broader regulatory reforms and infrastructure improvements continue to be important. Institutionalizing Public and Private Sector Dialogue 136. To develop and implement a reform agenda that addresses complex regulatory and infrastructure issues will require an institutionalizeddialogue between the Government, the private sector, and the civil society for setting priorities and finding solutions. The recent establishment o f an Advisory Industrial Council, to act as a think tank for the government, i s an important step forward. The Council and its Consultative Worhng Groups can serve as an apparatus to formalize the dialogue between the Government and the private sector. 137. Tamil Nadu may draw valuable lessons fiom the type o f Councils which has been key in the development o f international competitiveness in Asia, particularly in South Korea, Taiwan (China), Singapore, and some other countries. Key factors contributing to the success of these institutions include political support, a clearly-defined decision-making authority in the Council, an accountable 39 implementation mechanism, broad-based private sector participation that i s not perceive as representing special interest groups, and a public information and education campaign to build a shared consensus that can transcend any changes at the political level. 40 IV. REINVIGORATIYGAGRICULTUREGROWTH 138. While agricultural sector growth rates in Tamil Nadu were among the highest in India during the 1980s and early 1990s, deceleration in growth since the mid-1990s i s o f increasing concern to policymakers. During the 1980s agricultural GSDP grew at 3.4 percent, exceeding the all-India agricultural growth o f 2.9 percent. Adequate rainfall contributed to even higher growth inthe early 1990s: between 1989/90 and 1994/95 agnculture grew by 7.2 percent inTamil Nadu, compared with 3.1 percent in all of India. But between 1994195 and 1999/2000 agnculture in Tamil Nadu suffered from severe consecutive droughts and grew only 1.3 percent a year, compared with 2.9 percent for all o f India. As a result, the state's apcultural growth rate during the 1990s was only 2.9 percent a year, compared with 3.2 percent for all o f India. Regression analysis showed that a one percent increase in rainfall relative to the mean i s associated with a 0.3 percent increase in real apcultural GDP relative to the trend agncultural GDP. 139. Faster growth in apculture i s central to rural development and poverty reduction inTamil Nadu. Although agriculture accounts for only 14% o f Tamil Nadu's GSDP and nonfarm income accounts for about 50% o f rural household income, farm income accounts for about half o f household income for 35 million people (56 percent o f the state's population) who live in rural areas. Reinvigorating agnculture growth remains critical since a vibrant agriculture sector encourages industrial growth and farm income accounts for 78% o f the income o f the poorest 20 percent o f the rural population (with estimates ranging from 7.4 million people (20.6 percent o f the rural population) to 11.4 million (31.8 percent o f the rural population). Given the importance o f agriculture in the incomes o f the poor in Tamil Nadu, growth in labor-intensive agriculture could further reduce rural poverty through higher yields to small producers, higher real wages to agricultural laborers, and increased income and employment opportunities with forward and backward links to the rural non-farm sector Salient Features of Agricultiire 140. There are three salient features o f Tamil Nadu's agnculture that set the political economy context for searching a viable strategy for revitalizing agriculture growth: water scarcity; the large shares o f rice and sugar (both water-intensive crops) in total irrigated land; and the dominance o f small and marginal farmers in overall agriculture production. 141. Water scarcity. Tamil Nadu i s one o f the driest states in India. Per capita availability o f water resources in Tamil Nadu i s only 900 cubic meters a year, compared with 2,200 cubic meters for all o f India. The state's dry season lasts five months (January through May) even in good years, and severe droughts occur in 3 of 10 years, severely limiting cultivation o f crops between June and September. Irrigation through a combination o f canals, wells, and tanks increases the reliability and availability o f water for farming and i s essential for cultivating crops in much o f the state. But the seasonality and scarcity o f supply limit cultivation to only one crop per plot for most o f the state (in 1998/99 average cropping intensity was only 1.20 in Tamil Nadu, compared with 1.34 for all o f India). 96% o f surface water for irrigationhas been utilized and ground water resources are depleting. 142. Today the state relies equally on surface and groundwater sources for irrigation, though its reliance on groundwater has been steadily increasing. Approximately 30 percent o f the net irrigated area i s watered by canals and 21 percent by tanks, while 49 percent i s fed by wells. The remaining area i s irrigated by other sources such as streams and springs. Rain-fed agriculture, employing approximately 25 percent o f farmers, accounts for 46 percent of the net sown area o f 5.5 million hectares. 143. The agricultural sector faces increasing competition for water from industry and domestic users and intensifying interstate competition for surface water resources. Inmany parts o f the state, the rate o f extraction o f groundwater has exceeded recharge rates, contributing to falling water tables. Of a total o f 41 1.8 million wells inthe state, approximately 10 percent are now defunct. The depth o f bore wells in hard rock area has increased to as much as 600ft to 1OOOft. Today, use o f dug wells as a source o f irrigation i s only possible in canal and tank command areas; only bore wells remain operational in hard rock areas (mainly in the western part o f the state). Water quality i s also a growing concern. Effluentsdischarged from industries and heavy use o f pesticides and fertilizers have had a major impact on surface water quality, soils, and groundwater. 144. Rice and sugar. Rice and sugar, both water-intensive crops, account for nearly 40% o f gross cropped area and almost 70% o f irrigated area in Tamil Nadu. Rice dominates agricultural production, accounting for about a third o f total gross cropped area and nearly 60% o f irrigated area in Tamil Nadu (over 90% o f paddy i s irrigated). Pulses (18% o f total cropped area), millet (1l%), and groundnuts (10%) require less water than rice or sugar cane, and millet and pulses are grown almost exclusively on non- irrigated land. About 5% o f total cropped area i s devoted to sugar cane, all o f it irrigated (accounting for almost 10% o f irrigated land). Cotton occupies about 3% o f cropped area, and about a third o f the cotton crop i s irrigated. 145. The livestock and fisheries subsectors are also important inTamil Nadu. The state ranks second among Indian states in egg production and ninthinmilk production.'* In2001/02 Tamil Nadu accounted for approximately 6 percent o f national milk production and 11.9 percent o f egg production. The state i s also relatively well endowed with fisheries, accounting for 13.2 percent o f total marine fish production and 4 percent o f in-land fish production inIndia. Inall, crop agnculture, livestock, and animal husbandry account for 92.2 percent o f total value added in agriculture and allied activities, with fishing accounting for 4.5 percent and forestry for 3.3 percent. 146. Dominance of small and marginal farmers. The average size o f individually-held farms i s only 0.91 hectares, with over half the farms smaller than 0.5 hectares. Nearly three-quarters o f farms are smaller than 1hectare, accounting for only 30.2 percent total cultivable land. In comparison, the average farm size inIndia i s 1.41hectares, with 62 percent o f farmers holding less than 1hectare. Efficient Water Resource Management 147. Efficient water resource management i s a key priority for not only agriculture but also the entire state economy. It requires complex regulatory and institutional changes beyond the mediumterm. There are three main issues concerning the management of water resources: fragmentation and lack o f strategic coordination; distorted pricing o f water; and decline in the quantity and quality o f public investment in irrigation structure. 148. Institutions for water resource management. Institutional weaknesses have undermined proper management and development o f water resources in the state. As i s common in many Indian states, inadequate priority to and funding for operations and maintenance led to rapid deterioration o f surface irrigation. There was also minimal involvement o f farmers in the operations and maintenance o f irrigation systems. Management o f water resources i s fragmented and lacks strategic coordination across key institutions. But recent efforts have been made to address many o f the issues plaguing the water sector. 149. Important legislation has been enacted to require rainwater-harvesting structure in all public buildings to recharge the groundwater and arresting seawater intrusion; a massive and successful public campaign has been underway. The Government i s also moving away from fragmented management o f water resources toward a holistic river-basin framework, with the participation of all stakeholders. The Ranks are computed based on average production inIndian states between 1999 and 2001. 42 River-Basin Management Council in two out o f 17 river basins has been established, a first in India. A basin perspective helps minimize negative impacts on downstream human and ecological uses. A groundwater policy i s being prepared. The state has drafted a Water Policy, initiated steps for irrigation management transfer, and passed a Groundwater Regulation and Management Act, one o f the first states in India to do so. The State Legislative Assembly passed the Tamil Nadu Farmers Management of Irrigation Systems Bill (FMIS) inMay 2000. 150. There are three priorities for more efficient institutional management o f water resources. The first i s the need to develop a state-wide water resources management strategy which examines competing uses for water and a strategic framework for inter-sectoral allocation o f scarce water resources. The second i s the need to introduce specific, legally enforceable water entitlements to various users in a river basin and or aquifer framework. The third i s the need to clarify and develop rules and a framework for interplay among various agencies and institutions on the management o f water resources policy, Le., the River-Basin Management Council, farmers' water user associations, local governments, and Water Resources Organization under the Public Works Department. Irrigation management transfer i s at an early stage in Tamil Nadu and water user associations are not yet fully functional, though the FMIS Act mandates the transfer o f irrigation management to farmers. Further, the separation o f a regulatory function and service delivery function, currently held by the Public Works Department, would be required. 151. Pricing o f water and electricity. Under the current system o f economic incentives (prices, subsidies, taxes), the cost o f water for farmers and other water users does not reflect the scarcity value (opportunity cost) o f water. Throughout India, farmers using surface water for irrigation from canals or tanks are implicitly subsidized because water charges fall short o f operations and maintenance expenditures. Between 1990 and 2002 farmers using groundwater for irrigation in Tamil Nadu also benefited from free agricultural power supply. Subsidizing irrigation water means that the environmental costs o f water use are not being internalized, reducing incentives for water conservation, encouraging the cultivation o f water-intensive crops, and contnbuting to environmental degradation. The irrigation and agricultural power subsidies have contributed to the state's large fiscal deficit. These subsidies also have a highopportunity cost in terms o f other social and economic expenditures foregone. 152. In 2003, the Government of Tamil Nadu announced increases in irrigation water charges. Previously, water charges were levied by the Govemment o f Tamil Nadu at a base rate (which varied according to crop, season, and soil quality) plus an additional charge equivalent to six times the base rate. This additional charge was transferred to the local panchayats. Beginning in July 2003, an additional water charge o f Rs.150 per hectare was imposed, de-linked from any additional cess. With this change, farmers were to pay the original charge plus the Rs.150 per hectare. In addition, the FMIS Act empowered water user associations to charge users between Rs.250 and Rs.500 per hectare. This fee could be retained by the associations for operation and maintenance o f the systems turned over to them. These provisions for irrigation water charges allowed full cost recovery o f required operations and maintenance expenditures. The extent to which farmers were actually being charged the proposed water rates i s unclear. 153. The agncultural power tariff introduced in March 2003 included a flat rate for unmetered connections o f Rs.250 per horsepower a year and Rs.0.20 per kilowatt-hour for metered connections. Along with the reintroduction o f the agricultural power tariff, the government announced an income support scheme for smallholders and marginal farmers. Under the income support scheme, the Government o f Tamil Nadu provided smallholders and marginal farmers a transfer o f up to Rs. 1,250 a year. This was a significant step toward creating a more direct and transparent system o f subsidies to farmers and other target groups and ensuring the separation o f commercial operation o f the power utility from the need for subsidy. However, in a recent development power supply to agriculture i s now free 43 again and the direct subsidy scheme to farmers has been replaced by non-transparent budgetary support to the TNEB. 154. Inany case the flat rate charge of Rs.250 a year for a five horsepower pump set would have had only a small effect on net returns to land and management, reducing them by only 4.9 to 6.5 percent. Costs o f crop cultivation using well irrigation would have risenby only Rs.625 per hectare (annual charge pro-rated for one season) to Rs. 1,250 per hectare (for sugar cane grown over eleven months). However, such increases were also against the background o f repeat droughts starting in 1999 which have reduced significantly agriculture growth and income (para. 17). 155. Increases in electricity charges would have little effect on overall rice production and market prices but a major effect on sugar cane production. Since only about 10 percent o f rice area cultivated i s irrigated with well water (about 200 thousand hectares), changes in electricity pricing would have only marginal effects on production. And since rice i s also supplied by net public distribution (averaging 1.2 million tons a year from 1997198 to 2001/02, 18 percent o f net production) and private market trade from neighboring states (estimated at 1.O-1.3 million tons inthe drought year 2002/03), the effect o f lower rice production from well irrigated areas on market prices o frice would likely be small. Impact on sugar cane production would be much higher however, as essentially all sugar cane i s irrigated in part with well water. 156. If electricity charges are raised to the estimated marginal economic price of electricity to agriculture o f Rs.3.1 per kilowatt-hour, irrigation costs would rise to about Rs. 4,600 per hectare for paddy and sugar cane, reducing returns to land and management by 35.9 percent for paddy and by 23.8 percent for sugar cane. Likewise, total returns to land, labor, and capital (value added) fall sharply for paddy and sugar cane irrigatedby wells when the cost o f electricity for pumpingi s included. 157. It has been well recognized inIndia that the power subsidy is regressive, and farmers most at risk from drought are those without a pump set. But the reality i s that nearly three-quarters o f farms are smaller than 1hectare, which may not be all poor, but they are not too far from subsistence living. Unless an integrated service package i s provided to farmers, reducingpower cross-subsidy i s politically difficult. As a way to move forward, Tamil Nadu may carry out a small scale experiment o f providing a community o f farmers with the best facilities they need and assuring them o f a minimumo f their present income levels and asking them to pay for power and then examine whether their incomes levels increase or decrease inthis experiment. Challenges of Agriculture Diversification 158. Evenwith efficient management of water resources, diversification into higher value, less water- intensive products, such as fruits, vegetables, spices, and livestock products, may be one o f the most promising sources o f future agncultural growth, simply because o f the aggregate scarcity. Tamil Nadu's agro-climatic conditions are well suited for diversified agnculture. Rapidly increasing incomes and changing patterns of food demand also provide strong impetus for diversification. Increased agricultural diversification and private investments in processing for many o f the higher value agncultural commodities are likely to generate new rural non farm employment opportunities and contribute to higher rural incomes. 159. Notwithstanding its importance, there are daunting challenges indiversifying agriculture. Simply raising water and electricity tariffs has not only met political resistance but also would not provide sufficient incentives for farmers to move toward less water intensive crops. Currently in addition to having price incentives to grow rice and sugar, farmers engaging in rice and sugar production also have an extension system supporting them and a government procurement system to protect them against crop failures associated with droughts, market risks, and infrastructure constraints which reduce farm gate 44 prices. Pure market pricing solution and deregulation will not work in a complex context o f political economy and institutions. 160. Broader policy and institutional reforms are required to form a coherent package. The required reforms are: decentralizing a traditionally top-down centralized extension systemwhich cannot respond to market signals for more diversified agnculture; facilitating efficient markets; developing a rural credit market, and developing an insurance and safety net program to cushion against the risk o f diversification particularly for small and marginal farmers who rely mainly on agnculture subsistence income; and a delivery package to improve farmer income associated with gradual adjustment o f inputpricing. 161. Decentralizing the extension system. The agricultural extension system in Tamil Nadu, like the rest o f the country, i s still organized around a modified Training and Visit approach and continues to focus on major food-grains. There i s little coordination among line departments (agricultural, animal husbandry, fisheries) in their extension approach. The highly centralized extension system cannot meet the needs o f diversified crops and products. A wide range o f product types would require a decentralized and flexible extension system that can respond to market signals. 162. The extension system is slowly changing, however, and the promotion o f public-private partnerships in extension i s encouraging and offers potential for both cost-savings and greater efficiency. The Govemment o f Tamil Nadu also plans to link agricultural, horticultural, and agricultural engineering extension systems and units to improve the extension capacity for horticultural development. Related to extension, an assessment o f the state's comparative advantage in producing higher value crops for the domestic and export markets would also help in setting future research and development priorities. Re- orienting agricultural research to make it more farmer-responsive would likewise improve the output o f a system that has enjoyedmuch success inrice technology development inthe past. 163. Facilitating efficient markets. Well functioning agricultural markets are also important for successful agricultural diversification. Unlikemost Indian states, where wholesale marketing i s restricted to regulated markets, Tamil Nadu permits traders to transact sales outside o f regulated markets. Private markets account for about 90 percent o f the statewide trade inmajor crops. Regulatedmarkets, inwhich licensed traders bid for farmer produce through a tender system, account for only 10 percent. 164. Further, ifrecent policy reforms removingrestrictions on purchase, movement, stocking and sales o f paddy and 13 other crops by the private sector are consistently implemented at the local level, they can be expected to improve marketing efficiency, reducing the margin between producer and consumer/export prices.lg Reductions in marketing costs are also necessary in order for production increases to lead to higher agricultural incomes, particularly for perishable high-value products (e.g., fruits, vegetables, animal products). Private investments in processing and marketing horticultural and export crops have enjoyed some success (for example, turmeric exports from Erode). Contract fanning involving business agreements for the purchase of outputs and often the provision o f inputs and extension advice i s increasing, particularly for sugarcane, cotton, and horticultural crops. 165. Inadequate transport network including major ports i s a major constraint to well-functioning agriculture markets as it impedes the efficient transportation o f agnculture products fi-om farm gates to consumers, increasing transportation and delay costs. These are particularly important constraints for high-value agriculture products such as cut flowers, vegetables, h i t s , and fishery products. l9 In May 2003, following the February 2002 central Government order removing licensing restrictions on rice and 13 other crops, the state Govemment withdrew its licensing system for these crops. Restrictions on purchase, movement, stocking, and sales o f these commodities have been removed, though some provision remains for Govemment interventionin the case o f high marketprices for goods distributedthroughthe public distribution system. 45 166. Developing safety nets. Whether apcultural diversificationreduces rural poverty inTamil Nadu will depend on the extent to which small and marginal farmers, who dominate Tamil Nadu's agriculture (para.l46), adopt new technologies and have access to markets, the magnitude o f employment and real wage rate gains, and the size o f linkage effects with rural non-agriculture. Furthermore, periodic droughts bring about volatility in production and income, dramatically increasing vulnerability for small and marginal farmers, who rely o n subsistence living and have less non-farm income and assets to mitigate the impact of volatility. The implications o f an agricultural diversification strategy involving higher risk crops and capital-intensive technologies (drip irrigation) must be assessed. This assessment should review crop and drought insurance instruments, and the potential for innovations in these instruments to enable rural farmers, particularlypoor farmers, to better manage risks. 167. Increasing employment and earnings in the dry season is especially important for the rural poor. Increased availability o f water and greater efficiency o f water use inthe dry season (for example, through the widespread adoption o f drip irrigation) could enable cultivation of crops year-round, providing employment in agricultural production and processing. Dissemination o f new production technology and establishing markets for dry season crops remains an important unresolved issue, however. Contract farming (Box 4.1) may help overcome these problems, if competition between firms helps farmers maintain their share o f the value o f the final product sales. Box 4.1: Contract farminginTamilNadu Contract farming involves a business agreement betweena farmer and a f iinwhich the f i iprovides inputs,extension services, processing and areadymarket inreturn for a guaranteed source of supplyof the output product. Such arrangement between sugar mills and cane farmers has longbeenpracticed in TamilNaduand other parts o fIndia. For other products, however, restrictions on private sector trade motivated by a general mistrust o f traders, along with the structural characteristics of output markets (including the inability to differentiate products by quality or brand) have greatly limited the scope o f contract fanning. Rice: Beginning ina limited way in2002103, EIDParry sold approximately 60 tons o f improved seeds for super fine quality `Ponni' rice (enough for about 800 hectares) andprovided extension services to sugar cane farmers who sold sugar cane to the f m ' s sugar millinCuddalore, but were also willing to grow rice. With the improved rice technology, paddy yields were approximately 25 percent higher than normalyields o f 3.75 tonshectare. Moreover, because o f drought, marketprices were about 20 percent higher than the previous year. EIDParry later purchased the output. Inthe absence o f an explicit sales contract, though, the fiiriskednot beingable to purchase supply for its rice mills. The entrance o f large private fiminto rice markets has only beenpossible with the removal o f stocking limits (inMay 2003), and other restrictions on movements o fpaddy and rice. Cotton: Cotton contract farming started inabout 1200 hectares inthe 2002-03 season. The farmers have the option to sell cotton to the contractor or to any other b runder the marketpricesprevailingduring harvest period. For the services provided by the contractor, a nominal charge will b evied on the farmer on a unit area basis. Gherkin: Gherkincultivation andprocessing started inIndiainthe early' 90s and at presentis spread over 7,900 hectaresinthe three southem states o f Karnataka, Tamil Nadu andAndhra Pradesh. There are about twelve companies operating inthe state and each company has agricultural extension team o f 5-25 who identifyfarmers andthenenter into a buyback contract with them. ct farming for poultry is also practiced inTamil Nadu. For broilers, fimsupply chicks, ines andtechnical guidance to the farmers. The fmthen buy the birds when they are eight weeks old at a predetermined price. 46 168. Improving Public Expenditure. Although public expenditure on agnculture in Tamil Nadu i s relatively high among Indian states, the composition o f expenditure i s a problem. Expenditure on agriculture, allied activities, and irrigationas a share o f agricultural GSDP i s higher inTamil Nadu than in most major agricultural states in India. Between 1998 and 2000, public expenditure on agnculture equaled 11percent o f total agricultural GSDP inTamil Nadu, compared with 7.8 percent inall o f India.20 Public agricultural capital expenditure in the state i s relatively low as a share o f agncultural GSDP compared with the all-India average, while the opposite i s true o f revenue (i.e., current) expenditure. This i s a situation for concern since capital investment i s important for future growth. Furthermore, a large share o frevenue expenditure i s incurredon staff salary, and food and irrigation subsidy, leaving operating expenses under funded. Gross fixed capital formation in agnculture increased by 15 percent during the 1990s, due primarily to private capital formation, which accounted for 88 percent o f gross fixed capital formation inagriculture. 169. There remain, however, important roles for the public sector in promoting agro-food system and agro-enterprise development. Inaddition to policies that establish "rules o fthe game" and address market failures, public investments inthe road network to strengthen connectivity can contribute to reduced costs o f marketing. Reorientingpublic expenditure from consumption to growth-enhancing areas inkey public goods such rural roads, markets and agncultural research and extension will facilitate productivity improvements and diversification o f agnculture to higher value products. Tightening competition for limited fiscal resources heightens the urgency o f appropriate public expenditure reallocation. Institutional reforms within government departments to ensure improved quality o f delivery o f rural-related public goods and services i s also important (see Section I1 on fiscal reform and V on public administration reform). 170. Greater attention i s also needed for modernizing irrigation infrastructure and scaling up the adoption o f water-saving irrigation technologies. While the use o f sprinkler and dnp technology has been promoted inthe state, their high capital cost constraint widespread adoption by smallholders and marginal farmers. More affordable technology or a suitable system o f targeted subsidies should be developed to increase the use o f sprinklerand drip systems. 20Agriculturalpublic expenditureas a share of expenditure on Economic Services andAgricultural GSDP are averages of data from 1998/99-2000/01. 47 V. IMPROVINGPUBLICADMINISTRATION AXDENHANCINGSERVICE DELIVERY 171. While the main objective o f fiscal consolidation and reform i s to correct aggregate expenditure imbalance to create the fiscal space for priority spending in infrastructure and social sectors, it i s critical that the expenditure allocated to the priority sectors and areas be spent efficiently. To this end, the strengthening o f public expenditure management and financial accountability would need to be supported bypublic administrationreformto enhance service delivery. 172. Tamil Nadu has traditionally had capable public administration. It has moved from a near- average to a high-performing state as indicated by the HDI, which i s measured by longevity, education, and command over resources. Tamil Nadu's HDI, though ranked seventh place in 1981 rose to the third highest among 29 Indian states in 2001. Tamil Nadu has also done well in delivering key services: A recent survey conducted by the Public Affairs Center reveals that the state has the country's best public distribution and school education systems, and the second best public drinhng water and road transport services after Gujarat. This, o f course, i s not a uniform picture: health services, for example, are ranked fifth.21Yet, notwithstandingthisimpressive record, Tamil Nadu faces several critical challengesthat need to be addressed to preserve and extend the gains made so far. 173. To further improve public administration and enhance service delivery, the reform agenda would need to focus on the following areas which cut across sectors: (i) administrative reform to improve the efficiency o f the government by rationalizing and restructuring govemment functions, simplifying decision-malung processes, and improving the stability o f staff tenure; (ii) improving services with a large public interface through a combination o f measures, including agency reform and e-governance; (iii) transparency and anti-corruption by overhauling the public procurement system, ensuring the public's rightto information, and strengtheningthe anti-comption enforcement machinery. Rationalizingthe Role of Government 174. The civil service in Tamil Nadu has proliferated in the last twenty years: Tamil Nadu today possesses the highest ratio o f civil servants per hundred population in India o f any major state after Punjab. While restructuring the government has become imperative because o f the fiscal crisis, a fundamental issue i s to rationalize the role and functions o f the government in an increasingly market- driven economy. 175. To rationalize and restructure the civil service and improve its productivity, the Government constituted a Staff and Expenditure Reforms Commission (SERC) in December 2001 to systemically review and realign the roles and responsibilities o f each o f the 140 departments and identify redundant departments/functions/posts,including areas where the government should exit and let the private sector take over (Box 2.2). The exercise was carried out with the benefit o f extensive consultation within the govemment, including with staff associations and unions, as well as consultation with the public. 176. The SERC reports have identified about 85,000 surplus posts, and 113,000 vacant posts made feasible by hiringfreeze. The surplus posts are targeted mainly at lower-level administrative posts and at those government functions no longer required in an increasingly market-oriented economy. The rationale for eliminating these posts i s three-fold: (a) they are overstaffed in terms o f existing work norms; (b) they are overstaffed in terms o f the work that can be done by new technology; and (3) these tasks can be outsourced. There are no cuts inteachers, doctors and nurses, and police in front line service delivery. ''PublicAffairs Center, awell-known NGO in India, "Study of India's Public Services: Benchmarks for the New Millennium", April 2002. 48 177. The reduction inthe core civil service size (posts) by 2007/08 (from 2002/03) can be achieved by abolishing 85,000 posts using2002/03 as the base year. The abolishing o f the surplus posts will enable a more efficient allocation o f staff across departments within the targeted ceiling. The Government has commenced the implementation o f the SERC's recommendations by issuing orders to abolish 40,500 vacant surplus posts; an additional 10,000-15,000 posts which are currently live, are to be abolished in 2004105. Downsizing has been difficult to accomplish in India, and Tamil Nadu could prove to be no exception, notwithstanding solid gains to date. Moreover, the recent decision o f retaining the services o f 15,500 temporary workers hired last year i s not an encouraging sign o f government commitment. 178. The Government has also issued an order allowing for the "progressive" outsourcing o f all Group D categories (e.g., sweepers, security personnel), with the exception of office assistants, provided that new contractors give preference to existing employees on the nominal muster roll (NMR) or receiving daily or consolidated wages. The Government also plans to take actions on the SERC's recommendations to further streamline public administration. Stremillining Decision -Making 179. Like many Indian states, the process o f decision making i s cumbersome and involves a large volume o f paper work and multipleand often duplicatinglayers. 180. To simplify the decision-malung process, the SERC also reviewed the functioning o f the Secretariat, focusing on three issues: (i)improving efficiency through delegation to heads o f departments, level-jumping, the introduction o f the single-file system, and computerized file monitoring; (ii) greater flexibility for redeploying staff; and (iii)tightening up on discipline by tracking attendance. The Government issued an order in March 2002 permitting level-jumping-which reduces the number o f layers through which a file passes to no more than three-for a variety o f subjects including, among others, transfers, granting o f annual pay increments, leave matters, and disciplinary cases. Another order in November 2002 allows departments to introduce the single-file system, which permits heads of departments to send an entire file directly to the Secretariat for approval on various subjects. A comprehensive e-governance strategy i s being formulated to increase transparency, improve efficiency, and speed up decision making. Improving the Stability of Staff Tenure 181. Tamil Nadu i s not immune to the national phenomenon o f frequent staff transfers, which undermines service delivery by disrupting managerial continuity and generates corruption by creating a market inposts. 182. Responding to the problem o f pre-mature transfers, the Government introduced a system o f formal counseling for transfers inboth the Health and Education Departments. The new system i s aimed at reducing discretion in the process by holding annual, open consultation to allocate postings in the presence o f applicants based on transparent and publicly-known criteria. In 2004/05, the Government plans to introduce computerized counseling in health and education. The Government has also recently issued a Government Order (GO) covering the entire civil service. The GO specified transferring authorities, established norms for three- to seven-year tenure, limited transfers to 20% o f cadre strength and to the season only, and announced the creation o f a public transfer database on the internet to track transfers over time. The creation and implementation o f a public transfer database on the Internet to track transfers will provide a basis for formulating additional measures to improve the transfer process. Recent announcement o f transfers (after national elections) however raises questions about the implementation o f the GO. 49 Improving Critical Services with a Large Public Interface 183. While Tamil Nadu has done well in service delivery in some key areas relative to the rest o f the country, there i s still room for improvement. A number o f reforms are ongoing; these include improving Box 5.1: RuralAccess to Servicesthrough the Internet(RASI) inTamil Nadu RASI delivers a variety of services to rural villages using wireless technology connected to the state's fiber optic network and the Internet Service Provider. It is based on public-private partnerships involving the Indian Institute o f Technology Madras, N-Logue, a private company, the Center for Entrepreneunal Development in Madurai, and the GoTN. Invillages located in Melur Taluq and Madurai districts, the hosks were located in a prominent spot in the village. Villagers can send application forms on line to govemment offices for various certificates, which are collected by the operator and delivered to the applicants by hand. A web-camera installed at the kiosks allows people suffering from eye defects to send photos of their eye to Madurai's Eye Hospital for an initial analysis; this has been extended to photographing diseased crops for analysis at the local agricultural university. When several cases of malaria broke out in a nearby village, health officials received an e-mail and amved the following day. Critical information is online, such as crop prices, canal irrigation timings, guideline values, and eligibility criteria for schemes. RASI also offers business applications, such as linkingvillagers to buyers and sellers o f farm equipment or providing them access to life insurance offered through the website o f the Life Insurance Corporation of India. the Registration Department by introducing a computerized guidance value calculation software package for use inits sub-registries, and promoting the development o f kiosks in villages to improve rural service delivery and empower rural citizens (Box 5.1). Rural land records have also been fully computerized. Urban municipalities have computerized many services, including the issuance o f birth and death certificates, trade licenses and the collection o f property taxes and water charges. Metrowater, Chennai's public water utility, i s a model o f how to deliver services ina citizen-friendly manner. 184. Over the next few years, in addition to policy and institutional reforms in critical sectors such as water supply and sanitation, education and health to enhance service delivery, the Government plans to focus on improving 10 critical services with a large public interface, including regional transport services, commercial tax, stamps and registrationfor property transfers, district administration, and local bodies. It plans to accomplishthis through a combination o f measures such as e-governance, process reengineering, citizens' charters, and partnerships with the private sector. Procurement Reform 185. Tamil Nadu was the first Indian state to introduce legislation, in October 1998, to improve transparency in public procurement and to regulate tendering and contracting procedures o f govemment departments, statutory bodies, public sector enterprises and other local bodies. The Act has become a model for other.states wishing to reform public procurement (e.g., Karnataka, Andhra Pradesh, and Punjab). The detailed rules and tendering procedures under the Act took two years to finalize and the Act and the Rules came into effect only in October 2000. 186. The pace o f procurement reformhas been accelerated, focusing on the implementation of the Act. It has completed a three-year comprehensive procurement reform action plan, based mainly on a study carried out by the World Bank for the Government.22 A dedicated central "Procurement Procedure Cell" was created in the Department of Finance in October 2002 to supervise the implementation o f the agreed reforms and to serve as a central policy and oversight unit for public procurement in the state. Consultants have been selected for some high-priority items in the action plan, e.g., revision of Finance, 22 In November 2000, the World Bank carried out a Country Procurement Assessment Review (CPAR) for India, and selected Tamil Nadu as the first state to review, particularly to assess the effect o f the Transparency Act. The report made a number o f recommendations to further improve the efficiency, transparency and accountability o f public procurement procedures and to minimize opportunities for corruption, as also to introduce modem concepts and technology in the procurement system. 50 Accounts, Public Works codes and Manuals, and preparation o f a set o f Standard Tender and Contracts documents. 187. The implementation of the procurement reform action plan is expected to be completed over three years (2004/05-2007108). This will include: setting up a complaint/challenge/appeal mechanism; finalizing and issuing five sets o f Standard Bidding Documents; finalizing the revision o f Finance, Accounts, and Public Works codes; improving works procurement procedures; introducing code o f ethics for officials and the business community and tightening enforcement; evaluation o f reservation and exemptions with a view to provide a level-playing field; enlarging the scope o f rules to cover consultant selection procedures; and issuing guidelines and directives on procedural improvements. Rightto Inforniation 188. Tamil Nadu passed the country's first Right to Information (RTI) Act in 1997; the Act itself, however, was flawed. Exemptions are numerous and broad enough to make virtually all government information off limits to the public if interpreted literally. While most RTI Acts in India, and globally, provide for automatic and pro-active release o f certain categories o f information on a suo-motu or routine basis, there i s no such provisioninthe Tamil Nadu law. It also lays down no penalties for non-compliance and fails to establish an independent channel for appeals. The law falls below GoI's standards set in the Freedom o f Information Act (2002), as well as the standards o f state laws in Delhi, Karnataka, and Maharashtra. 189. The Govemment announced in the 2003/04 Tamil Nadu Governor's Address the need to revise the kght to Information legislation. The Govemment is currently preparing a new draft law that will provide for minimal exceptions, an independent appeals process, penalties for non-compliance, and more automatic disclosure o f information by departments. The GoTN hopes to submit this bill to the state legislature soon, for the purpose o fproviding a sound basis for implementationover the next three years. Enforcing Anti-Corruption 190. Inaddition to ongoing systemic reforms to prevent corruption (e.g., procurement reform, business deregulation, e-governance, and fiscal transparency), enforcement efforts need strengthening. The Vigilance Commission and its investigating agency, the Department o f Vigilance and Anti-Corruption (DVAC) function as government agencies. Quite unlike neighboring Karnataka's independent L o k Ayukta who has the authority to investigate both corruption cases and grievances arising out o f maladministration involving civil servants and Ministers and exercises supervisory authority over the police wing o f the L o k Ayukta. The performance of the D V A C has been mixed, with high conviction rates drawn from a very small number o f registered cases, mostly easy-to-prove ones for whom traps were set. Only 1% o f petitions filed with the D V A C between 1993/94 and 2002/03 resulted in prosecution in any given year. Neither the Vigilance Commission nor the D V A C possessed a public website to disseminate performance information. 191. Building on various, ongoing governance reform initiatives, a Government Order was issued in February 2004 to establish a high-powered Govemance Reform Commission to: (i) an action plan prepare with monitoring indicators for improving 10 critical services with a large public interface; (ii) the suggest structure and modality for an independent institutional mechanism to oversee public grievance management and handle corruption complaints in service delivery; and (iii) recommend measures to strengthen the government's capacity to implement a broader program o f governance reform including modalities for encouraging well-informed public debate and building broad-based consensus on priority issues. The Govemance Reform Commission is, however, yet to begin functioning. Meanwhile, the government has announced the constitution o f `Service Delivery Improvement and Grievance Redressal 51 Committees' at the levels of district, department and secretariat departments while a state-level joint council headedby the Chief Secretary would be reconstituted. 52 VI. STRENGTHENINGPOVERTYMONITORINGANDEVALUATION 192. Notwithstanding good progress in reducing poverty and improving human development the poverty line (para. lo). There are also emerging human development challenges (paras 12-13). While indicators in Tamil Nadu, poverty remains high, with 12-17 million out o f 62 million people still below broad-based economic growth i s necessary for poverty reduction, programs targeted at the poor, disadvantaged and vulnerable are equally important to ensure that growth i s more broadly shared and that the poor will be protectedagainst the potentialimpact o f for example the reduction o f subsidies. 193. Tamil Nadu has a plethora o f poverty-reduction programs. One o f the most important ones i s the public distribution system for food security. Another well-known program i s the Noon Meal Scheme to provide incentives, particularly to the poor children for school enrollment. It will be important to strengthen monitoring and evaluations o f targeted poverty-reduction interventions in order to inform better ways to improve targeting and rationalizationacross programs. 194. Effective poverty targeting needs to start with the identification o fthe poor and understanding the nature o f poverty (both income and non-income) and identifying the key determinants o f poverty. From available data - mainly NSSO, National Council o f Applied Economic Research and National Family Health Survey (NFHS) -some important lessons regarding the relationship between poverty in Tamil Nadu and geography, asset ownership, occupation, demographics, health and education, and agnculture could be drawn. 195. These messages yield a number o f broad implications regarding targeted poverty-reducing programs. Interms o f targeting, there appears to be a case for paying special attention to the rural areas in the Coastal North and the South, and possibly to the urban areas inthe Coastal North. Scheduled Castes and Scheduled Tribes (SCISTs) also appear to face particular barriers to upward mobility, and the data suggest that these stem at least inpart from three sources: access to land, education, and regular non-farm employment. Indeed these three barriers, although especially acute for SC/STs, tend to be characteristic o f the poor more broadly. Addressing them will therefore be a vital part o f any poverty alleviation strategy pursuedby the state. 196. There are a great many questions regarding poverty inTamil Nadu that are difficult to answer for lack o f data. The list o f questions which remain unanswered i s extremely long, but a couple o f examples may serve to illustratethe consequences o f data limitations facing poverty analysis. 197. First, since National Sample Survey (NSS) data are only representative at the NSSO regional level, constructing more disaggregated regional poverty measures has not been possible. From the point o f view o f policymakers, and in particular against a background o f decentralization, there i s a real interest inknowing more about the geography o f poverty at the level o f 29 districts or the 384 blocks. For a state as large as Tamil Nadu with a population o f 62 million, data disaggregating at the four regional level can not provide detailed geographic profile o f the poor-i.e., where the poor are. Methods have been developed in recent years to combine survey with census data so as to produce such detailed geographic profiles o f poverty, but such methods have not yet been implemented in India. Such information i s thus unlikely to become available inthe short run. 198. Similarly, although we can glean some insights from NFHS data, we cannot paint a very detailed picture o f urban poverty. This i s clearly unsatisfactory since urban poverty promises to be a growing challenge with the rapid urbanization o f the state. 199. Second, although data such as the NFHS do provide us a richpicture o f women's quality o f life, it has little data regarding income or consumption. This makes it difficult to map these indicators into an understanding o f poverty. Given that the Tamil Nadu government has been laying increasing emphasis 53 on assisting women, it would no doubt be useful to systematically identify the challenges facing poor women. Although constraints on employment and earnings appear to be an important deterrent to upward mobility amongst women, as well as other disadvantaged demographic groups, especially SCISTs, we are not inthe position to elaborate on the nature o f these constraints, particularly inurban areas. 200. Developing a comprehensive poverty reduction strategy will involve more investment inpoverty monitoring. This i s obviously a grand undertaking, but the recent Below Poverty Line (BPL) survey i s an important step in this direction. It asks a number o f important questions regarding household characteristics, including income, asset ownership, and a few occupational and demographic characteristics. Since it i s a census, the BPL i s amenable to the addition o f modules, which could be used to acquire data representative at least at the district level. Such an undertakmg would be considerably facilitated by virtue o f the fact that much o f the necessary survey infrastructure i s already in place. The B P L therefore offers a valuable opportunity to fill gaps in our knowledge regarding the nature and determinants o f poverty in Tamil Nadu. Much remains to be learnt, however, about the quality and reliability o f the BPL data that are currently being collected. 201. The BPL type o f surveys can also be supplemented by sectoral MIS data. Various government departments in Tamil Nadu such as Social Welfare, Education, Health, and Rural Development collect and maintain useful data such as nutrition, infant mortality, primary school enrollment and dropout rates, maternal mortality. One deficiency i s that these data from various departments are not integrated. With the ambitious e-governance project initiatedto modernize the information system o f the state government, a useful and important step can be taken to establish a central poverty and human development monitoring unit under the Planning Department to integrate monitoring (currently done by each o f the concerned departments) for synergy and a common database that will facilitate systematic evaluations and policy feedback on poverty-reduction interventions. 202. The capacity to monitor the progress o f poverty and human development and link that with overall policy and poverty-reduction interventions remains critical. There i s also scope for aligning the various programs listed in the Tenth Plan to improve coordination and targeting: many programs are not coordinated, with multiple, overlapping and sometimes different objectives. The government has plans to conduct evaluations o f key programs. The Noon Meal Scheme may be a good program to begin the exercise. A comprehensive and well-coordinated monitoring and evaluation system will be essential to streamline the various projects currently envisaged and further strengthen the government's efforts in poverty reduction. 54 VII. REFORNICHALLENGES AKD RISKS 203. Tamil Nadu faces the longer-term challenge o f reform for accelerating economic growth and reducing poverty. Repeated droughts and growing waters shortages have heightened the importance o f structural transformation. Such transformation will reduce the vulnerability o f the economy to periodic drought, and free up scarce water resources to higher value-addition activities inthe industrial and service sectors. The faster growth o f these two sectors would help absorb agriculture surplus labor and reduce currently highunemployment rate o fthe state. 204. Reform priorities for the structural transformation to accelerate economic growth and reducing poverty are: 0 Fiscal reform remains an immediate development challenge for Tamil Nadu, and India. Fiscal stabilization, correcting aggregate imbalances, and improving the composition o f expenditure i s critical for creating the fiscal space for priority spendingininfrastructure and social sectors. 0 Fiscal reform must be accompanied by strengthened public expenditure management and public administration to improve the effectiveness o f public spending and service delivery. 0 Fiscal adjustment alone without a complementary focus on the investment climate and economic growth i s insufficient. Faster economic growth positively influences not only debt sustainability but also employment andincome generation, facilitatinglarger distribution o freformgains. 0 Evenassuming the success o f fiscal adjustment inaccordance with the MTFP, public investments in infrastructure and basic services are likely to remain a fraction o f investment needs. Thus, public-private partnerships in infrastructure financing and development under an appropriate policy and regulatory framework are essential. 205. It needs to be understood that many important policies are not within the purview o f the state govemment. Policies o f the central government affect fiscal sustainability and growth in states. These central policies include the share o f the state in central tax devolution, the introduction o f VAT, a macroeconomic framework that may affect interest rates on state debt, regulatory policies on private sector activities such as labor market regulations, business exit and bankruptcy procedures, and infrastructure policies and development affecting major ports, air markets, inter-state highways etc. 206. Agenda for fiscal reform. Putting Tamil Nadu's fiscal reform in the Indian context, fiscal consolidation remains the most serious macroeconomic challenge facing India, with the general govemment deficit estimated at close to 10% o f GDP and the debt/GDP ratio at 81% in 2003/04. Almost half o f the consolidated fiscal deficit i s made up o f states' deficit. States' fiscal reform has shown to be difficult, its progress uneven across states and several states have experienced varying degrees o f policy reversals. Reforming civil service salaries, pensions, subsidies improving tax administration and reforming the power sector remain politically challenging. State reforms will be accelerated by the linkmg o f central fiscal resource transfers to states with their fiscal performance. In this regard, strengthening o f the initiatives already undertaken by GoI, such as the Fiscal Reforms Facility, will be important. A schematic list o f necessary reforms in the broad area o f fiscal and public expenditure management i s presentedat Annex 2. 207. MTFP will need to reflect the vision o f the state in consonance with the state's Fiscal Responsibility Act. To operationalize the development vision, policy formulation and budgeting need to be better integrated by ensuring that fiscal constraints are realistically identified and appropriately incorporated into each o f these processes. As recognized by the GoTN, the fiscal crisis offers an opportunity to address systemic institutional weaknesses and minimize the recurrence o f fiscal crisis. 55 Recent policy actions undermine the reform framework and question govemment commitment. Institutional reform includes upstream budget formulation to downstream execution and accounting and audit (some o fwhich will no doubt depend on consensus at the national level). 208. Tamil Nadu, (and India) will need to find a politically viable solution to power sector reform to resolve the twin problems o f shortage and poor quality o f power supply, as a viable power sector i s critical for achieving fiscal stabilization, accelerating economic growth, and ensuring sustainability o f ground water resources which are depleting at an accelerated rate. Although power theft and corruption are a lesser issue in Tamil Nadu reducing cross subsidy i s critical to the financial viability o f the power sector. To get the reform levers aligned so vested interests are not alienated and, most importantly, that poor people receive their rightful delivery o f social services, i s the challenge. 209. Equally challenging i s expenditure reform which reduces and/or redistributesbenefits. First, user charges have to keep step to improve service delivery. Second, there i s limited scope for Tamil Nadu to increase its own tax revenues under the existingtaxation powers conferred on states. Third, the increased infrastructure and social spending using newly created fiscal space (if fiscal reforms are successful) can only be gradual, and even in the long term cannot be increased rapidly if economic growth i s not accelerated and if tax powers are limited. Fourth, it will take time for infrastructure and social spending to translate into tangible benefits. 210. The reform program o f the government made a good beginning and its impact is positive inthe fiscal turnout upto 2003/04. However, recent policy choices o f reversing critical reforms already undertaken will impede expenditure restructuring efforts and jeopardize the gains made thus far. This poses a threat to fiscal consolidation besides affecting the credibility o f the MTFP and fiscal and budgetary discipline. Particularly in the power sector, the government seems to have painted itself into a comer, and it i s hard to see how inthe current environment any plan for financial recovery can be worked out. If,as seems likely given what hasjust happened, there are no further tariff increases before the next state election, expected in2006107, power sector losses could, inthat year, exceed what it projectedinthe reformist business plan by as much as Rs 2,000 crore or more than 1% o f GSDP. In such a scenario, the consolidated deficit will be back at or above pre-reform levels, and productive spending will be crowded out by power subsidies. Tamil Nadu has no choice but to retum to the path o f fiscal consolidation. Otherwise the success o f the reform program initiated by the Government looks uncertain with every possibility o f the state reverting to the fiscal distress highlighted inGoT"s 2001 White Paper. 211. Investment Climate: The reform agenda deals with not only regulatory policies and practices concerning all factor markets (labor, land, and capital), but also regulation o f entry/exit and tax policy and administration. Further, removing substantial infrastructure bottlenecks-power, road network, water supply, etc.-top the reform agenda. The wide scope o f issues is not surprising, given that international competitiveness involves all critical chains o f investment, production and marketing. The agenda will thus require an institutionalized dialogue between the Government and the private sector for setting priorities and finding solutions. The private sector mustbe a sounding board and source o f information in formulating policy for the business environment. 212. Priority reforms comprise o f the following areas: labor market flexibility; a more responsive urban land supply system; a more efficient tax policy and administration; continuing reform o f entry and operation; power sector reform; and scaling up PPP for sustainable infrastructure development. Many o f the issues concerning investment climate are exclusively or largely within the purview o f the central government. This report confines itself to options for the reform agendas which are partially or mainly within the purview of the state government. These are presented at Annex 3. It must be recognized that there i s a balance between comprehensive reform and strategic selectivity. Therefore, the proposed agenda serves as a menu o f options from which a strategic yet programmatic reform agenda could be 56 formulated based on the Government's own internal consultation, opportunities and constraints. Many o f the proposedreforms involve complex institutionalreform that will take efforts beyond the mediumterm. 213. Agriculture. Traditional sources o f agricultural growth in Tamil Nadu face major constraints. Seasonal water shortages, increasing land degradation, continually shnlung farm sizes and rising costs o f agncultural labor represent serious constraints that need to,be overcome if future growth in agriculture i s to be realized. Given the existing constraints, diversification into less water-intensive higher-value products, including fruits, vegetables, spices, and livestock products, i s one o f the most promising avenues for increasing agncultural growth. Tamil Nadu's agro-climatic conditions are well suited to diversified agnculture. Furthermore, rapidly increasing incomes and changing food demand patterns provide strong impetus for diversification. Increased agricultural diversification and private investments inprocessing for many ofthe higher valued agnculturalcommodities are likely to generate newruralnon- farm employment opportunities and contribute to higher rural incomes. Contract farming and other private sector initiatives should be encouraged, though the impact o f these business arrangements on farmer incomes should be evaluated, as well. 214. Overcoming the constraints faced by the agricultural sector in Tamil Nadu, and accelerating growth in agricultural production and the rate o f rural poverty reduction, will require appropriate policies and investments in four priority areas: improving the efficiency o f water use; increasing the effectiveness o f public expenditures and agricultural extension; spurring the development o f agricultural markets; and maximizing the real income growth o fthe rural poor. 215. More specifically, there are several options that Tamil Nadu could consider to manage its scarce water resources. These include: scaling up the pilot river-basin framework for managing water resources holistically, allowing interagency coordination and public-private partnerships; introducing specific legally enforceable water entitlements to various users ina river basin and or aquifer framework; changes in electricity, water and crop prices to change the financial incentives for imgation and crop choice; improved management practices and irrigation technologies (such as drip and sprinkler irrigation) and new investments incanals and water storage (coupled with improved operation and maintenance). 216. Tamil Nadu i s the only state in India without a separate department o f irrigation: administration o f irrigation in the state i s part o f the Department o f Public Works. Two new agencies are needed: a regulatory agency to allocate the share o f water resources to agnculture, industry and other uses, and an imgation department focusing on irrigation delivery systems. 217. Re-introduction o f agriculture power tariff (both flat rate on pump sets and metered) became a highly contentious issue in Tamil Nadu during national elections and were reversed. International experience with income support programs also provides several important lessons for providing clear incentives and containing fiscal costs, including the need for targeting to poorer farmers (e.g., paying more per hectare as farm size increases, with a ceiling on the numbers o f hectares eligible for payment), an effective delivery system for the transfer payments, and a limit on the number o f years for which producers will be eligible for payments. 218. Gradual step towards marginal cost pricing o f electricity, (perhaps combined with compensation to farmers in the form o f income transfers or a more reliable electricity supply), would help rationalize water use inTamil Nadu. Metering o f farmers i s critical to link agricultural tariffs to consumption levels. Metering will also enable power subsidy to be better targeted. If farmers costs and incomes varied according to the amount o f electricity (and water) used with well irrigation, farmers would have an incentive to shift some land from water-intensive crops (rice and sugar cane) towards less water-intensive crops (including cotton, maize and vegetables). Greater attention to marketing infrastructure, strengthening the research and extension system to meet the needs o f diversified agriculture, the 57 development o f tools for farmers to better manage risks, and improving irrigation pump set efficiency may create an environment within which higher power charges would be more palatable for farmers. 219. It i s importantto sequence the raising o f water and electricitytariffs as part o fbroader package of coherent policy and institutional reforms. These reforms are: decentralizing a traditionally top-down centralized extension system; facilitating efficient agncultural markets; developing a rural credit market, and developing an insurance and safety net program to cushion against the risk o f diversification particularly for small and marginal farmers who rely mainly on agriculture subsistence income; and a delivery package to improve farmer income associated with gradual adjustment o f input pricing. 220. Greater attention i s also need for scaling-up the adoption o f water saving irrigation technologies and modernizing irrigation infrastructure. Improving the productivity o f rainfed agriculture will require new investments and increased emphasis on community participation with sound technical inputs to improve the success o f watershed programs. A basinperspective should be adopted inimplementation o f all watershed programs to ensure that these initiatives do not have negative impacts on downstream human and ecological uses. 221. Rationalizing public expenditures and shifting expenditures from subsidies to investments inkey public goods such rural roads, markets and agricultural research and extension will facilitate productivity improvements and diversificationo f agriculture to higher value products 222. Poverty Monitoring and Evaluation. There appears to be a case for paying special attention to the rural areas in the Coastal North and the South, and possibly to the urban areas in the Coastal North. Scheduled Castes and Scheduled Tribes (SC/STs) also appear to face particular barriers to upward mobility, and the data suggest that these stem at least inpart from three sources: access to land, education, and regular non-farm employment. Indeed these three barriers, although especially acute for SCISTs, tend to be characteristic o f the poor more broadly. Addressing them will therefore be a vital part o f any poverty alleviation strategy pursued by the state. Given that the Tamil Nadu government has been laying increasing emphasis on assisting women, it would no doubt be useful to systematically identify the challenges facing poor women. Constraints on employment and eamings appear to be an important deterrent to upward mobility amongst women, as well as other disadvantaged demographic groups, especially SC/STs. 223. Developing a comprehensive poverty reduction strategy will involve more investment in poverty monitoring. This i s obviously a grand undertaking, but the recent BPL survey i s an important step inthis direction. It asks a number o f important questions regardinghousehold characteristics, including income, asset ownership, and a few occupational and demographic characteristics. Since it i s a census, the BPL i s amenable to the addition o f modules, which could be used to acquire data representative at least at the district level. 224. The GoTN expends considerable thought and effort inundertaking, the formulation o f goals and identification o f targets for its anti poverty programs. However, different programs are not always coordinated, with multiple, overlapping and sometimes conflicting objectives. Encouragingly, however, many schemes appear to be, or have the potential to be, broadly focused on issues which data suggest are important to the poor. More needs to be done regarding the design and implementation o f poverty alleviation schemes. 225. Monitoring and evaluation (M&E) requires strengthening. This i s not a problem particular to Tamil Nadu: it i s common to all o f the states in India, as it i s to most o f the developing world. Monitoring o f extant anti-poverty policies and social services more generally is, however, important if one i s to gauge whether implementation i s proceeding according to plan and achieving its stated objectives. This i s a continuous process, instrumental in identifying problems to b e addressed. Impact 58 evaluation involves isolating the effects o f a particular policy -- assessing its effect on welfare and living standards. The GoTN i s an ideal agent for engaging inM&E, given its voluble commitment to combating poverty, openness to receiving feedback, and rich human capital resources. Impact evaluations are most appropriate to programs which are innovative, replicable, involve substantial resource allocations, and have well-defined interventions. It i s also obviously the case that impact evaluations are best conducted on policies which are viewed as important to social welfare. 226. Service Delivery and Public Administration: The followiag measures are suggested for improving the efficiency o f Government administration: (a) Implementation o f the SERC recommendations across departments and the Secretariat over a three year time-period, resulting inthe elimination o f surplus posts; (b) Introduction o f a computerized file-monitoring system to reduce delays in file movement, in conjunction with level-jumping, the single-file system, and greater delegation o f powers; (c) The Government has already issued a Government Order on transfers covering the entire civil service. The creation and implementation o f a public transfer database on the Internet to track transfers will provide a basis for formulating additional measures to improve the transfer process including computerized counseling in health and education and adopting legislation to limit transfers; and (d) Creating a human resource database for civil servants' to facilitate better employee tracking, forecasting, and career planning. 227. Reducing Corruption: (a) Creation o f an independent institutional mechanism to focus on corruption and grievance redressal in service delivery, and greater transparency in the functioning o f D V A C (e.g., tabling o f reports within three months o f their submission, creation o f a public website with data on complaint numberdtypes, pendency rates, and outcomes over time); (b) Adoption o f a new Tamil Nadu Right to Information (RTI) Act, with minimum exceptions, strong suo-motu disclosure provisions, and independent appeals process; and (c) Implementationo f further procurement reforms. 228. Strengthening Service Delivery: (a) Revision o f citizen charters' for agencies with large public interface on a priority basis (e.g. district hospitals) and use o f surveys to provide feedback; (b) Continuation o f service delivery improvements in key agencies (e.g., Registration, Transport, Revenue, and Public Distribution System); and (c) Expansion o f E-Governance by promoting single-point delivery o f services, beginning with Chennai, and the spread o f rural information kiosks. 229. Electoral politics and capacity constraints may lead to reform uncertainty and political sensitivity to many reforms. What i s critical i s the political commitment to reform, as well as the sequencing and prioritization of reforms, and careful managing o f trade-offs inreform gains, costs, and risks. To do so, it i s important to build a broadly-shared consensus through public debate and to carefully design a minimumset o fpoliciesand programs to compensate for the impact o freform, so as to maintain a critical mass o f support for reforms to proceed. GoTN's capacity to manage a complex and growing reform agenda requires strengthening. Substantial capacity building and broad-based knowledge partnerships can help address the management o f reforms in priority areas such as water resources management, agriculture diversification, public expenditure management, and public-private partnerships in infrastructure financing and development. 59 60 Annex I.A Functional Reorganization Scheme for the Commercial Tax Department Move to a functional structure. Moving from a territorial to a functional structure in the commercial tax administration i s probably the single most important reform initiative the Tamil Nadu government can take to reform tax administration. The reorganization would have to be carried out at the headquarters and territorial levels. It would create the necessary organizational basis for separating and strengthening the key tax administration functions o f registration, audit, collection, and taxpayer services. Figure A1.1 outlines a typical functional tax administration structure. FigureAl.1: Tax AdministrationStructure I Commissioner CommerdalTaxes J.C. JC. J K J.C. J,C. D.C. F.A a CA D.C. Registration Audit Collection Taxpayer Service Administration Legal Information and Assessment and Technology Enforcement Inorder to mitigate risks and develop a clearer understanding of the operation ofa functional tax administration, the reorganization could be implemented in stages and begin with a pilot site. The establishment o f a new large taxpayer unit in the Commercial Tax Department would offer an ideal venue for such a pilot. Create a special structurefor large taxpayers: A small number o f large traders contribute the bulk of sales tax collection in Tamil N a d ~ . *To address the compliance risks and the special ~ service needs o f this group o f taxpayers, the government should set up a special large taxpayer unit responsible for the administration of the largest 200-500 traders in the country, and staffed with senior and experienced tax officials. Such a unit would also considerably facilitate the introduction o f a VAT. As discussed above, the unit should be organized along functional lines. Streamline the territorial structure of tax administration: Following the successful piloting o f the functional structure in the large taxpayer unit, the reorganizationneeds at the territorial level should be addressed. The current 323 assessment circles should be abolished and tax administration tasks transferred to the 40 district offices. Circle offices would, however, be maintainedand transformed into service posts where appropriate. Strengthen the hunian resources of the Coniniercial Tax Department: A professional and specialized tax administration requires an appropriate level o f highly qualified staff. This requires increasing the percentage o f senior staff at officer level inthe administration. 23Currently, the largest 400 taxpayers-representing 0.37% of assessments-account for 75% of total sales tax collections. 61 Strengthen the enforcement fiutction: A total o f 4,646 inspections o f dealers were conducted in fiscal year 200112002. These inspections resulted in the assessment o f additional taxes and penalties amounting to Rs.211.86 crore, which accounts for only 3% o f total sales tax collections. Enforcement productivity i s thus extremely low. To enable the department to counteract tax evasion more effectively requires strengthening risk analysis for case selection; moving from a routine desk inspection to a targeted field inspection system; introducing an enforcement management system with clear plans and regular review o f performance o f enforcement units; and training o f professional staff. Establish a vigilance unit: The Commercial Tax Department has an audit wing responsible for internal audit o f its operations. The audit wing focuses primarily on reviewing the correctness o f the assessment work, but does not assume responsibility for ensuring integnty and counteracting corruption in the tax administration. To investigate taxpayer allegations against tax officials and detect corrupt practices and officials in the department, a special vigilance unit should be established. The current commercial tax system has two unusual features that complicate contpliance by the business community: First, the current sales tax system i s not based on self-assessment. Temporary self-assessment i s possible only for a small group o f small taxpayers with a turnover o f less than Rs.10 crore and-in the case o f the sales tax-only if the taxpayer declares a 10% increase in the taxable turnover over the preceding year. Modem tax administrations, however, have moved to a universal self-assessment scheme for sales tadVAT and have, when the scheme i s introduced in phases, started not with small taxpayers, but with the small group o f large taxpayers, for which self-assessment i s more feasible and important. A review o f the self- assessment approach chosen and the development o f a roadmap for moving to universal self- assessment will therefore be required. Second, efforts should be made to facilitate the registration process for sales taxpayers and, in future, for VAT taxpayers. The process i s comparatively long-almost one month-while many tax administrations manage to register taxpayers within 72 hours from the moment o f filing the application. The Government is, understandably, concerned about the risk o f registering non-existent or fly-by-night firms, and efforts to reduce these risks are perfectly justified. Nevertheless options should be considered to make the registration process more taxpayer-friendly, without neglecting the need to mitigate risk. The options should also include reviewing the requirement to re-register businesses periodically and charging annual registration fees. Tamil Nadu faces substantial problems in determining the taxable value of real property and enforcing payment of stamp dutiesfor property transfers: Valuation for stamp tax purposes i s based on a guideline value,. which i s determined by a Value Fixation Committee. Guideline values are frequently subject to disputes and are not upheld in court. Taxable transactions are either not reportedto the Registration Department, or the registration i s delayed. Frequent use o f fake stamps causes additional revenue losses, so that the actual tax revenues collected by the Registration Department are far below the revenue potential. Problems in collecting stamp duties, especially on real estate transfers, cannot be addressed exclusivelyfrom a tax administration angle: They are part o f a broader problem o f keeping up- to-date records on property ownership and sales. A well-functioning cadastre system i s necessary for eliminating the possibility o f unrecorded property transfers. A revision o f cadastral records therefore needs to be launched. Tamil Nadu can benefit in this respect from the experience of some states that have embarked on this exercise already; in particular the experience o f Uttar Pradesh and Kamataka with using satellite technology for this purpose could be relevant. On the tax side, the interest and penalty system for delayed applications for registeringproperty transfers needs to be reviewed. Efforts to set more reliable property values need to be pursued, in 62 particular by establishing a Central Valuation Committee, following the recommendation of the Empowered Committee o f State Finance Ministers and the positive experience with the operation o f such committees in other states. Further computerization o f the valuation process, talung into account experience in Andhra Pradesh, and especially in Maharashtra, could facilitate property valuation. Valuation for stamp duty purposes and for assessment o f the urban land tax could be harmonized. The overall result o f the reform process should not only be an increase in stamp duty collections, but a quicker processing o f registration requests, which would support a more dynamic real estate market. 63 Annex 2: Budget and Financial Management Reforms Budget and Policy Formulation Strengthening policy formulation 0 Establish an apex Policy Reform Committee linked to a network o f policy research instituteshniversitiesto upgrade quality o f policy proposals. 0 Establish an annual forum with stakeholders to report on development progress and to invite comments on proposedpolicy initiatives. Strengthening budget formulation As a priority, develop capacity to undertake multi-year revenue forecasting in Department o f Finance. Formalize the functioning o f a standing Expenditure Review Committee as part o f the annual process o f reviewing budget submissions to eliminate unproductive programs and improve efficiency o f existingprograms. Ensure budget preparation process encompass expenditures due to all "new policy, provision o f a new facility, or any substantial alteration incharacter or extent o f an existing facility." Eliminate policies or schemes that violate established budgetary review and vetting process. Initiate time-bound implementation o f expenditure rationalization recommendations o f the Staff and ExpenditureReform Commission. Establisha worhng group to (a) develop recommendations on rationalization and accessibility o f budget documentation and (b) update the budget manual. Initiate Zero-Base Review o f Schemes and programs; close those with doubtful benefits and merge others, which are similar innature post review. Adjust budget schedule to ensure that the Appropriation Act is passed by the beginning o f the fiscal year. Strengthening budget execution 0 Initiate and complete a full review o f budget execution procedures (cash management, release o f cash or letters o f credit and payment, control processes, predictability and scope for departmental virement) to identify factors that contribute to under-spending, arrears, end-of-year spike in spending, etc. Implementrecommendations from such review. 0 Introduce quarterly circulars providing departments with information on anticipated cash disbursement`letter o f credit limits for next quarter. 0 Delegate greater financial powers to allow managers more discretioninmanaging inputs.Provide departments with greater authority over discrete blocks o f budget appropriationand increasing the unito fparliamentary appropriation. Improving fiscal accounting 0 Adopt a clear and internationally standard definition o f the fiscal deficit to be reported in the fiscal accounts. 0 Initiate improvements to accounting system within the current system. Prepare and publishregular reports on fiscal and revenue deficit. Monitor and report payment obligations, arrears and guarantees issued. o Discourage andlimittransfer ofresources from consolidated fundofthe stateto the public account. Improve timeliness and comprehensiveness of reconciliationo f accounts across treasury, department and accountant general. 64 0 Develop and implement a medium term strategy for networked computerization o f financial transactions and records and adoption o f department-based financial management. 0 Improve and strengthen the internal audit function. Improving accountability to Legislature 0 Ensure more complete and prompt departmental responses to audit paragraphs. 0 Avoid delays inobtaining ex post legislative authorization o f expenditure inexcess o f appropriation. Taxation Policy and Administration Tamil Nadu's own tax revenue effort i s amongst the highest in Indian states. Nonetheless, there i s considerable room for improving the efficiency, equity and administration o f the tax system to increase revenue yield and investment friendliness. Tax policy Continue preparation for the introduction o f the VAT; and prepare appropriate legal acts to levy tax on goods and services that should cover taxes such as the Special Additional Sales Tax and some type o f presumptive taxation applicable to small dealers not covered by the VAT. Consider to switch State Excise from the current specific excise to ad valorem levied on the Maximum Retail Price o f alcoholic beverages. Streamline duties on dutiable instruments (especially financial instruments), moving some to ad valorem. Minor duties may be either abolished or increasedto justify the collection costs. Consider raising non-transport vehicle lifetime taxes to 8% in line with some other states. Revamp fees for permits, registration, licenses, fitness certificates on motor vehicles, increasing revenue potential from road tolls, and raise the "green tax." In addition, part o f the road user charges can always be incorporated into the fuel/diesel price through increased sales andor excise taxes. Abolish EntryTax on motor vehicles and goods upon introduction o f VAT. Tax Administration Short term 0 Prepare a five-year tax administration reform strategy. 0 Streamline reporting and accountability arrangements for revenue collection. 0 Establisha Central Valuation Committee for fixing guideline values. 0 Establisha vigilance unit inthe Commercial Tax Department (CTD). 0 Issue a uniformtaxpayer identification number and revise taxpayer registrationprocess. 0 Create a pilot Large Taxpayer Unit (LTU) inthe CTD, structured along functional lines. Medium-term 0 Prepare an annual audit plan and training for auditors. 0 Prepare a HR audit and training plan. 0 Introduce self-assessment for large taxpayers. 0 Start roll-out o f LTUconcept. 65 Long-term 0 Fullroll-out o fLTUconcept: move to a functional tax administration organization. 0 Abolish assessment circles and transform circle offices into service points where appropriate. 0 Transfer responsibility for collecting other taxes to CTD. ExpendititreReform Pension reform Year 1 Produce assessment o f transition costs o f moving from pay-as-you-go financing to funding. The government will have to pay half o f the overall contribution as employer. This has fiscal implications that depend on the chosen contribution rate and, more importantly, on how many current civil servants are allowed / encouraged to move to the new scheme. The `transition cost' mustbe inline with fiscal realities. Determination and announcement o f parameters o f the new defined contribution scheme. A series o f parameters remain to be determined before the scheme can be started. K e y among these i s the contribution rate, the retirement age, the payout options and the treatment o f the GPF account. These may be influencedby GoI's recent announcements inthese areas. Determination and announcement o f rules regarding the choice between the existing defined benefit (DB) scheme and the new defined contribution (DC) scheme for those already participating in the former. The conditions o f this option must be designed in line with fiscal plans. Implementation o f new information systems requiredto track individual accounts for members o f the defined contribution scheme on a regular basis for government offices inChennai. Year 2 Disseminationof information regardingthe pension systemoptions available to civil servants. Civil servants faced with a choice as to whether to stay inthe current DB scheme or move to the new D C scheme shouldbe provided with adequate information. (This assumes that there i s a choice rather than a mandate). Implementation o f information system for tracking individual accounts in the defined contribution scheme to at least 90 percent o f eligible government employees Development o f plan to link new scheme to the infrastructure created under the Pension Fund Regulatory and Development Authority. Adopt revalued lifetime average earnings to plan for the target replacement rate when designing the provisions o f the defined contribution scheme. Index pensions automatically to price increases instead o f ad hoc wage indexation every 10 years through Pay Commissions. Salary control 0 Continue staff rationalization as per the Staff Expenditure and Reform Commission's recommendations. 0 Linkwage indexationdecisions to capacity to pay. 66 Subsidy reduction 0 Improve targeting o f the poor inthe PDS by incorporatingincomeiasset criteria and gradually raise public distribution systemprice o frice to BPL issue price o f the govemment o f India. 0 Evolve guidelines to manage growth ingrants-in-aid o f salary expenditure to higher educational institutions and private aided schools. 0 Audit subsidies andphase out subsidies ofdoubtful benefit. Improving capital outlay and non-wage O&M 0 Reallocate expenditure towards non-wage O&M expenditure incritical sectors and capital outlay. 0 Leverage capital outlay to scale up public private partnerships. 0 Progressively reduce budgetary support to Public Sector Enterprises and cooperatives through different means such as loans, grants, waivers, non-recovery and Ways & Means support. Reform of Public Sector Enterprises State Transport Units 0 Continue containment o f salary and pension growth. 0 Continue to reduce operational loss. 0 Improve staffhus ratio. 0 Implement phasedprogram o f privatizing selected routes and services, subject to legal case inthe court being ruled infavor o f the govemment. Other public sector units and cooperatives 0 Formulate a time line for restructuring and divestment and transparent guidelines for divestment. 0 Formulate a strategy and actionplan for sales o f assets and divestment. 0 Carry out environment audit for units to be closed / sold. 0 Conduct training and counseling program for retrenchedworkers. Power sector reform 0 Formulate and implement a comprehensive reform program addressing the need for sector restructuring for transition to a financially viable power sector -in accordance with the requirements of India's new Electricity Act 2003 (Act) as well as specific needs o f the state. 0 Increase cost recovery from domestic power consumers. 0 LimitTNEB'sborrowingrequirement. 0 Combine metered power supply to agriculture with a package deal to improve agricultural services delivery combined with marginal cost recovery level power tariff, efficient pump sets, less water intensive crops, and direct subsidy to the poor. 0 Address highpower purchase costs and introductiono fcompetition inthe power sector. 0 The open access provisions in the Act, if carefully implemented, can result in substantial private investments in generation with reasonable costs. 0 Improved cost recovery from rural areas to be planned to balance increase incosts with improved service delivery, so as to prepare for the reduction incross-subsidy. 67 Management of Debt and Contingent Liabilities 0 Eliminate off-budget borrowings. 0 Continue debt swaps and seek extension o f swap scheme to other costly borrowings. 0 Eliminate the existing system o f incentives for mobilizing small savings. 0 Abide by the limit on risk weightedguarantee limits under FRA. 0 Establish a set o f formal rules to govern eligibility o f PSUs, cooperatives and statutory boards for government guarantee. The rules could take into account financial statements, record o f profitability, performance on past guarantees, priorities o f government, etc. 68 Annex 3. Reforms to improve the Investment Climate Labor market flexibility Within the constraint o fnationallegislation, the state government can explore ways to rationalize the legal framework governing labor and statutory compliance requirements to create elbow room for contractual labor relationship and for easingthreshold for retrenchment. More specifically, the following can be considered. Short term 1. Carry a complete review o f the entire spectrum o f Labor Laws governing Tamil Nadu and the machinery needed to implement these laws. 2. Bringin flexibility to Factory Act on working hours, overlapping o f shifts work days, working on holidays either through State Amendments o f the Act or through exemption under section 65. 3. BringinState Amendments to the Contract Labor (Regulation and Abolition) Act 1970. Through the amendment, redefine what constitutes a "core" activity and reclassify many activities to the "non-core" list, allow hiringo f contract labor inactivities, like sanitation works, security services, canteen and catering services, health services, courier services, gardening and maintenance services, transport services, and other activities o f intermittent nature even if they constitute core activities (e.g. hiring contract labor in production line to meet unexpected export orders). Furthermore, the decision should be left with the firms to decide what i s core and non core. 4. Amend the notifications under the Shops and Establishment Act to remove inflexibility regarding working hours and also dismissal o f employees. 5. Review licensing procedures in all the labor related laws to remove unnecessary procedures, simplifyandensure compliance. 6. Remove inflexibilities introduced in the past by the state related to the Industrial Disputes Act. Initiate State Amendments to amend Chapter VB like Maharastra government and perhaps follow the example o f the Andhra Pradesh government, which i s the process o f initiating amendment to Chapter VB to raise the number to 1000. Mediumterm 1. Amend Section 16 o f the Trade Union Act, 1926, which contemplates constitution o f a separate fund for political purposes. Empower the Registrar of Trade Unions to adjudicate upon a dispute as to which o f the office bearers are validly elected and limit the number o f unions in any establishment. 2. Initiate State Amendments to the Industrial Disputes Act 1947 and Shops and Establishment Act to allow termination under reasonable grounds, differentiation between the termination o f temporary and permanent employee, introduction o f probation period and confirmation period, removal o f compulsory regularization o f a person who works for more than 2 years and to provide for court awarded compensation instead o f reinstatement and permitting compulsory retirement under the Industrial Disputes Act. 3. The Presiding Officers o f the Labor Courts to be given Special Training or to have trained personnel for the resolution o f the disputes. 4. Evaluate the need for MinimumWages Act (1948) and the Rules 1950. Extend the exemption if necessary. Longer term 1. Consolidate the 27 Central and 7 State Laws into Industrial Relations and labor matters. Like most other developing countries, steps need to be taken to consolidate labor regulations to 5 main legislation to govern, first the relationship between employer and employee (Employment Act), 69 second to govern quasi judicial body that arbitrates between employer and employee (Industrial Disputes Act), third to govern the activities o f employees inunions (Trade Unions Act), fourth to govern welfare and compensation (Workman Compensation Act) and fifth to govern safety and security at work (Occupational Safety Act). 2. Carry out institutionalreengineering to make the regulation o f labor effective and cost efficient. 3. Consider establishing an independent body like Labor Regulatory Authority to deal with retrenchment and closure o f factories. Urban land market reform The focus should be on rationalizingregulations on zoning and development controls, project approval and land acquisition processes, and developing a more effective planningandmanagement system to facilitate infrastructure development. 1. Initiate a land market assessment in the Chennai metro area and select towns to identify an inventory o f publicly owned land. 2. Complete a throughreview o freal estate and land development regulations (regulatory audit). 3. Identify neededreforms. 4. Prepare report on the results o fthe assessments. 5. Hold series o f meetings with government and private sector stakeholders on the results. 6. Follow up support to assist government and private sector to implement reforms. 7. Monitor implementationofreforms and assess and evaluate their effects. Streamlining regulationsof entry and operation 1. Work with private sector representativesinthe construction and real estate business to review problems inentry regulations. 2. Develop an actionplanto ease entry regulations. 3. Identify clearance delays ifany. 4. Complete the ongoing exercise reforms to consolidate 53 retums/registers into one common form. 5. Extendthe simplified entry approval system for large investment projects (Rs.250 million) to cover small and mediumprojects as well. Scaling up private sector involvement in infrastructure service delivery The government has announced plans to establish an Infrastructure Development Board and an infrastructure fund o f Rs.200 crore in the 2003 Industrial Policy. A Infrastructure Development Enabling legislation i s being prepared. All o f them aim to scale up public and private partnership in the development o f infrastructure. Ingoing forward, key issues the government may consider are: 1. Reduce dependence on national and state budgets by promoting access o f Urban Local Bodies, utilities and govemment agencies to adequate and sustainable sources o f infrastructure finance. 2. Strengthen creditworthiness o f local bodies and state utilities for accessing private capital by providing selective credit enhancement where required to enable them to set a track record for future borrowings. 3. Develop financing mechanisms with targeted use o f state government contribution and guarantees and linkmunicipal financing with domestic capital markets. 4. Choose and select projects which best fit state/local priorities for economic development and have sound economic value. /- 70 Inorder to mobilize financing inarobust PPP framework, the following essentials would needfocus: 1. Develop an appropriate and comprehensive regulatory environment which establishes rules o f the game for PPP and Private Sector participation; determining service ownership, developing legal framework for concessions, contract enforcement, bankruptcy and lender remedies. 2. Bringabout financial discipline and enhance revenues through, depoliticisingtariffshser charges, implementing overall cost recovery and creating dependable infrastructure revenue streams. 3. Linkstatetransfers to performance benchmarlung for ULBsandutilities. 4. Buildand enhance capacity in local bodies for project design and structuring, project evaluation, contracting and implementation, financial planning, budgeting, and strategic planning. 71 FiscalData Annex 1.1 (a) :Fiscal Summary MARCH 1990191 1991192 1992193 1993194 1994195 1995196 199W97 1997198 1998199 1999100 2000101 2001102 2002103 2003104* 2004105 BE RupeesBillionin current prices STATE GOVERNMENT Rl"D""e 50.4 60.3 68.8 78.8 90.5 104.4 117.8 134.5 141.3 160.7 180.5 185.1 204.6 234.1 245.4 State's Own Rwrnurr 34.6 41.1 46.4 53.2 64.3 78.5 86.9 96.7 106.5 120.2 137.2 142.6 158.1 1775 190.8 Tar 31.2 37.3 416 48 0 58.3 715 798 869 963 1092 1228 130 I 143 4 1594 174 4 NOD- Tar 3 4 38 4 s 5.2 6.0 7 0 7 1 9 9 103 110 144 12 5 14 8 18 0 16 5 Cem'aI Taxes 15.8 19.2 22.4 25.6 26.1 15.9 30.9 37.8 34.8 40.5 43.2 415 46.3 56.7 54.5 SharedTaxes L O O 119 142 15 5 17 4 18 I 21 7 273 24 I 26.7 27 8 28 7 30 5 35 4 37 I Grants 5 8 7.3 82 10 I 8 8 7 8 93 105 107 138 154 13 8 15 9 21 2 17.4 Non- lnterest Expenditures 56.8 68.1 79.8 83.1 93.9 103.2 126.4 140.3 169.1 192.1 205.4 201.6 233.1 228.7 2623 Salaries (incl GIA for ducation) 235 257 288 32 3 36 2 41 6 48 3 55 6 74 7 82 4 82 5 82 6 79 8 79 6 94 8 Pmiions& RcdremtBencfiu 3 5 4 4 5 6 6 0 6 4 7 9 10 8 12 9 170 27 5 29 5 30 6 33 4 32 9 46 0 olw Pmdm 35 4 4 4 8 5 2 5 5 6 9 9.0 I 1 0 14 7 26 8 26 I 24 5 26 0 26 5 34 3 Non- Wage 0 & M 9 2 I 0 8 115 12 7 14 1 I S 0 17 3 18 I 19 4 18 2 18 7 16 8 21 4 24 8 28 7 O!hn Revenue Expmdirures 0 0 0 0 0 0 0 1 0 1 0 1 0 2 0 2 0 1 0 1 0 1 0 1 0 2 0 6 0 1 SubsidiesandTransfers 148 213 270 24 6 25 6 29 2 36 4 41 3 39 7 40 5 49 2 45 I 75 I 65 2 56 8 Subsidies 5 8 10 I 13.3 10.8 12 8 I 5 2 17 9 17 5 I 5 0 14 4 23 0 22 9 38 6 18 6 17 5 FoodSubsidy 2.6 3 6 6 8 3 9 5.2 8 0 100 100 5 0 7 1 154 15.3 124 8 0 7 8 Power Subsidy 1 8 4 3 3 6 4 0 5 1 35 38 3 6 3 3 25 0 9 3 2 22 1 0 0 0 0 Hydcl SHhg Subsidy 0.0 25 1.3 Others 1 4 2 1 2 5 2 5 2 3 3 1 3 2 3.4 5 6 4 0 5 1 3 5 2 8 65 7 3 TranEfns 9 0 112 138 13 8 12 8 140 18 5 23 8 24.7 26 1 26 I 22 2 36 5 47 1 39.3 oIw Compensationto Loealbodies I 1 2 0 2 9 13 1 3 2 1 3 1 7 9 102 102 9 7 7 2 15 6 14 8 14 3 Capiul Outlay 2 3 3.6 4 0 6 3 4 8 5 9 9 4 121 163 201 246 24 I 20 5 21 8 33 3 NetLending 35 2.2 2 8 1 2 6 7 3 5 4 2 0 0 1 9 3 4 0 9 2 2 2 6 4 4 2.5 TN Primly Surplus (+)I deficit (-) -6.4 -7.7 -10.9 -4.3 -3.5 1.2 -8.6 -5.8 -17.8 -31.6 -25.0 -16.5 -18.6 5.4 -16.9 InterestPa)".! 4 8 5 9 7 3 10 0 I 1 5 138 159 176 212 271 309 35 I 41.1 47 0 52.3 Go TNRevenueSurplus(+YDeficil(-) -5.4 -7.9 -113 -6.8 -3.5 -3.2 .10.9 -11.3 -30.8 -35.2 -30.3 -25.3 -46.5 -15.4 -33.4 Go TN FIscdSurplus(+)/Deficit(-) -11.2 -13.7 -18.2 -143 -15.0 -11.6 -24.5 -23.4 -49.0 -58.7 -55.8 -51.6 -69.7 -41.5 -69.2 I IMemo Ilrms POWER SECTOR Rcvmue(Excl PowerSubsidy) (I) 145 168 212 26.3 351 413 449 531 568 648 758 822 946 1161 1230 CashOperaringExpmdirurc(excl Depreciation)(2) 154 150 196 250 299 360 400 476 549 676 766 943 I000 1097 I125 EamingbcfareInt,Dcpm,Tax&AppropmiEBIDTAli3)=i11-(21 -09 1 8 I 6 1.4 5 1 5 3 4 9 5 5 2 0 -29 -09 -121 - 5 4 6 3 105 I"tereSt(4) 23 1.7 2 7 3 0 3 4 3 8 4 2 4 7 4 9 58 6 4 6 5 7 2 8 0 8 9 Tlaxation(5) 0 0 0 0 0 0 0 0 0.0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 NCILmsIRofit icxcl DepmlbcforcSubsidy [.I+) (6) -32 0 1 -11 -16 1 7 15 0 6 0 9 -29 -87 -7.3 -185 -125 -17 I 6 CapitalOutlay(7) 6 2 6 6 3 7 113 9.9 122 103 9 4 114 120 167 I 1 3 139 148 160 Ovnall FinancingRequacmt before Subsidy (+I-) I81 9 4 6 4 4 9 129 82 10.7 9.7 85 143 207 240 298 264 165 144 CONSOLIDATED ACCOUNTS RWlIlYll 64.8 76.3 89.3 104.4 124.4 144.3 161.2 185.9 196.4 223.5 253.9 264.5 297.8 347.9 366.1 Total Expenditures 81.4 90.8 1075 126.1 138.4 161.4 189.7 208.5 257.6 308.3 335.8 342.5 372.3 4013 449.9 RevmueExpmdirure 71 7 79 8 98 I 108 9 1210 142 4 167 7 192 8 226 8 264 8 290 6 305 I 334 8 365.0 398 0 CapitalOutlayandNet Lending 9 7 I 1 0 9 4 174 17 3 20.0 22 0 15 7 30 8 43 5 45 2 37 3 37 6 37 3 51 9 ConsolidatedRevenueSurplus (+)I Defieit e) -6.8 -3.5 -8.8 -4.4 3.4 1.8 -6.4 -6.8 -30.4 -41.4 -36.7 -40.6 -36.9 -17.1 -31.8 Connollditod Surplus(+)I Deficit(.) ( 9 F(1H8)1(11) -16.5 -14.5 -18.2 -21.8 -14.0 -18.2 -28.5 -22.5 -61.2 -84.9 -81.9 -77.9 -74.5 -54.0 -83.7 GrossBorrowingRequirrmnt -18.7 -16.9 -21.1 -24.9 -16.6 -21.0 -32.0 -26.8 -66.9 -91.5 -89.8 -89.4 -97.9 -90.2 -115.1 GoTN FiscalDeficit (10) -11.2 -13.7 -18.2 -143 -15.0 -12.6 -24.5 -23.4 -49.0 -58.7 -55.8 -51.6 -69.7 -41.5 -69.2 d w GrossBudgetarySupport to Power (11) 4 1 5 6 4 8 5 4 9 2 5 2 5 7 9 3 2 1 -5 5 -2 1 35 21 6 3.6 -0 1 Pawn Subsidy 1 8 4 3 3 6 4 0 5 1 3 5 3.8 3 6 3 3 2 5 0 9 3 2 22 I 0 0 0 0 CapitalOutlay& Net Lmding 2 4 1.3 1 2 1 4 4.1 1 6 1 9 5 7 -1 2 -8 0 -3 0 0 3 -0.5 3 6 -0 I Noo-Po\*erDeficit~(12)=(10)+(11) -7.1 -8.1 -133 -8.9 -5.8 -7.4 -18.8 -14.1 -46.9 -64.2 -57.9 -48.1 -48.0 -37.9 -693 Debt StOekofGoTN 573 67.8 80.0 95.1 114.1 128.5 145.5 168.4 104.8 259.7 313.3 356.7 433.0 4745 5553 Gunr~nters 16.2 29.3 17.4 34.0 39.3 48.0 50.2 53.3 51.6 72.1 96.2 87.9 91.9 108.1 90.0 IGoTN Debt and Guanntecs 835 97.1 97.3 119.0 153.4 176.4 195.7 221.6 256.4 331.9 409.6 444.6 524.9 582.7 64S3 Power Sector Numbers for 2003104 arc forsasu tomthe businerrplan In2003104 the acual consolidatedfiscal andrcvmucdcficit arc higherby Rs 10bn accordingto tbc Gavemmcnt Since detailsare not availablethis have no1bem incolparatd in this table Tne aemal consolidatedfiscal deficit in 2003104 i s 3 8% of GSDP 72 I 1.1 (b): Fiscal Summary(%) GSDP) MARCH 1990191 1991192 1992193 199394 1994/95 1995196 1996197 1997D8 1998199 1999100 2OWlOl 2001102 2002103 2003104' 2004105 BE (As a Percent of GSDP) STATE GOWRNMENI RlVD""D 16.1% 163% 16.0% 13.7% 13.2% 13.3% 13.2% 13.0% 11.9% 12.7% 12.8% 125% 133% 13.1% 13.7% State's Own Revenue 11.0% 11.1% 10.8% 9.3% 9.4% 10.0% 9.7% 9.3% 9.0% 9.5% 9.7% 9.6% 103% 10.4% 10.6% Tax 100% l O i % 9 7 % 84% 85% 91% 85% 84% 81% 86% 87% 8 8 % 93% 9 4 % 97% Non-Tax 11% 10% 11% 05% 09% 09% 08% 10% 09% 05% 1 0 % 0 8 % 10% 11% 09% Centra1T*XW 5.0% 5.2% 5.2% 4.5% 3.8% 33% 35% 3.6% 2.9% 3.2% 3.1% 2.9% 3.0% 3.3% 3.0% SharedTaxes 32% 32% 3 3 % 27% 2.5% 2 3 % 24% 26% 20% 2 1% 20% 196 2 0 % 2 1% 2 I% Grants 18% 20% 15% 18% 13% 10% 10% 10% 09% II% 11% 09% 10% 12% 10% Non- Interest Expenditures 18.1% 18.4% 185% 14.5% 13.7% 13.2% 14.1% 135% 14.3% 15.2% 14.6% 13.6% 15.2% 13.4% 14.6% Saiarier (incl GIA for education) 7 5% 7 0% 6 7% 5 6% 5 3% 5 3% 5 4% 5 4% 6 3% 6 5% 5 E% 5 6% 5 2% 4 7% 5 3% Pensions & Retirement BeneficI 11% 12% 13% 10% 0 9% I0% 12% 12% 14% 2 2% 2 1% 2 1% 2 2% i5% 2 6% o/w Pensions 11% I2% 11% 0 9% 0 E% 0 9% I0% 11% 12% 2 I% 1 5% i6% 17% 1 6% 19% Nan-Wage0 k M 2 5% 2 9% 2 7% 2 2% 2 1% I9% 1 9% I8% I6% 14% 1 3 % i1% 14% 15% 16% Ober RevenueExpenditures 0 0% 0 0% 0 0% 0 0% 0 0% 0 0% 0 0% 0 0% 0 0% 0 0% 0 0% 0 0% 0 0% 0 0% 0 0% Subsidiesand Transfers 4 7% 5 E% 6 3% 4 3% 3 7% 3 7% 4 1% 4 0% 3 4% 3 2% 3 5% 3 0% 4 9% 3 E% 3 2% Subsidies 18% 2 7% 3 1% 1 5% 15% 19% 2 0% 17 % 13% II% 16% 15% 2 5% 11% I0% Food Subsidy 0 8% 10% 16% 0 7% 0 7% 10% 11% 10% 0 4% 0 6% II% I0% 0 8"% 0 5% 0 4% Power Subsidy 0 6% 11% 0 8% 0 7% 0 7% 0 5% 0 4% 0 3% 0 3% 0 2% 0 1% 0 2% 14% 0 0% 0 0% Hydci Swng Subsidy 0 0% 0 0% 0 0% 0 0% 0 0% 0 0% 0 0% 0 0% 0 0% 0 0% 0 09% 0 0% 0 0% 0 1% 0 1% Others 0 4% 0 6% 0 6% 0 4% 0.3% 0 4% 0.4% 0 3% 0 5% 0 3% 0 4% 0 2% 0 2% 0 4% 0 4% Transfers 2 9% 3 0% 3 2% 2 4% I9% I8% 2 1% 2 3% 2 1% 2 1% 19% 15% 2 4% 2 8% 2 2% o/w CompensationIO Local bodies 0 3% 0 5% 0 7% 0 2% 0 2% 0 3% 0.3% 0 8% 0 9% 0 E% 0 7% 0 5% 10% 0 9% 0 8% Capital Outlay 0 7% 10% 0 9% 1 1% 0 7% 0 8% 10% I2% 14% 16% 17% 16% 1.3% 1 3% I9% Net Lending 1 1 % 0 6% 0 7% 0 2% 10% 0 5% 0 5% 0 0% 0 2% 0 3% 0 1% 0 1% 0 2% 0 3% 0 1% I NP~imzrySurplus (+Y deficit (-) -2.0% -2.1% -2.5% -0.7% -05% 0.2% -1.0% -0.6% -2.3% 4.5% -1.8% -1.1% -1.9% 0.3% -0.9% lnteres! PPymenU 15% 16% 17% 17% 17% 18% 18% 17% 18% 2 I% 2 2 % 2 4 % 2 7 % 2 8 % 29% Go I NRwenueSurplus(tprfiUt(-) -1.7% -2.1% -2.6% -1.2% -0.5% -0.4% -1.2% -1.1% -2.6% -2.8% -2.1% -1.7% -3.0% -0.9% -1.9% Go I N Fiscal Surplus(+Wefirit(-) -3.6% -3.7% -4.2% -2.5% -2.2% -1.6% -2.7% -2.3% -4.1% -4.6% -4.0% -3.5% 4.5% -2.4% -3.9% GSDP 313.4 369.6 430.1 574.8 6875 184.9 894.9 10355 1182.8 1265.0 1411.5 1485.9 1537.3 17053 1793.1 Memo Ilems POWER SECTOR Revenue(Excl Power Subsidy)(l> 46% 45% 4.9% 46% 5 1% 53% 5 0 % 5 I% 4 8 % 5 1% 54% 5 5 % 6 2 % 6 8 % 69% Cash Operating Expenditure (excl Dqreciatlon) (2) 4 9% 4 0% 4 6% 4.3% 4 4% 4 6% 4 5% 4 6% 4 6% 5 3% 5 4% 6 3% 6.5% 6 4% 6 3% Eaming before l n Dqm, Tax & Appropm (EBIDTA) (1)-(2) ~ -0 3% 0 5% 0 4% 0 2% 0 7% 0 7% 0 5% 0 5% 0 2% -0 2% -0 1% -0 8% -0 3% 0 4% 0 6% inrerest(4) 07% 0 5 % 06% 0 5 % 05% 05% 05% 04% 04% 05% 0 5 % 0 4 % 0 5 % 0 5 % 0 5 % Taxalion (5) 00% 000% 00% 00% 00% 00% 00% 00% 00% 00% 00% 00% 00% 009% 00% NetLowQrofit (excl Depm) before Subsidy(4+)(6) .IW% 00% -0 3% -0 3% 0 3% 0 2% 0 1% 0 1% -0 2% -0 7% -0 5% .I2% -0 E% -0 1% 0.1% CapiulOutlay (7) 20% 18% 05% 20% 14% 16% 12% 09% 10% 0 9 % 12% 08% 09% 09% 0 9 % Overall Financing Requirementbefore Subsidy(+/-) (8) 3 0% 1.7% 11% 23% 12% 14% 11% 08% 12% 16% 17% 205% 17% 10% 08% CONSOLDATED ACCOUNTS RlW""l3 20.7% 20.6% 203% 18.2% 18.1% 18.4% 18.0% 18.0% 16.6% 17.1% 18.0% 17.8% 19.4% 20.4% 20.4% Total Expenditure 26.0% 24.6% 25.0% 22.0% 20.1% 10.7% 21.2% 20.1% 11.8% 14.4% 23.8% 23.1% 24.2% 23.6% 25.1% RevenueExpenditure 22 9% 21 6% 22 E% 18 9% 17 6% 18 1% 18 7% 18 6% 19 2% 20 9% 20 6% 20 5% 21 E% 21 4% 22 2% Capital Outlay m dNet Lending 3 1% 3 0% 2 2% 3 0% 2 5% 2.5% 2 5% 15% 2 6% 3 4% 3 2% 2.5% 2 4% 2 2% 2 9% ConsolidateRevenue Surplus (+) IDefiUt (-) -2.2% -0.9% -1.0% -0.8% 05% 0.2% -0.1% -0.7% -2.6% -3.3% -2.6% -2.7% -1.4% -1.0% -1.8% Consolidsled Surplus (+Y Deficit (.) (9); ( l b ( 8 M I l ) -5.3% -3.9% 4.1% -3.8% -2.0% -23% -3.2% -2.2% -5.2% -6.7% -5.8% -5.2% 4.8% -3.2% -4.7% GrassBorrowing Requirement -6.0% -4.6% -4.9% -4.3% -2.4% -2.7% -3.6% -2.6% -5.7% -7.2% -6.4% -6.0% -6.4% -5.3% -6.4% GoTN FiralDefieit (IO) -3.6% -3.7% 4.2% -2.5% -2.2% -1.6% -2.7'% -2.3% 4.1% 4.6% -4.0% -3.5% 4.5% -2.4% -3.9% d w Grar BudgetarySupport to Power (11) I3% 1 5 % 11% 0 5% I3% 0 7% 0 6% 0 9% 0 2% -0.4% -0 I% 0 2% 14% 0 2% 0 0% Powa Subsidy 0 6% II% 0 8% 0 7% 0 7% 0 5% 0 4% 0 3% 0 3Y" 0 2% 0 I% 0 2% 14% 0 0% 0 0% CapitalOutlay & Net Lending 0 7% 0 4% 0.3% 0 3% 0 6% 0 2% 0 2% 0.6% -0 1% -0 6% -0 2%, 0 0% 0 0% 0 2% 0 0% Non-PowrrDifidtr(I2)=(10)+(11) -2.3% -2.2% -3.1% -1.5% -0.8% -0.9% -2.1% -1.4% -4.0% -5.1% 4.1% -3.2% -3.1% -1.2% -3.9% Debt Stock of GaTN 18.3% 18.4% 18.6% 16.5% 16.6% 16.4% 16.3% 163% 17.3% 20.5% 22.2% 24.0% 28.2% 278% 31.0% Guarantees 8.4% 7.9% 4.0% 5.9% 5.7% 6.1% 5.6% 5.1% 4.4% 5.7% 6.8% 5.9% 6.0% 6.3% 5.0% G I N Debtand Guarantee 16.6% 263% 22.6% 22.4% 22.3% 22.5% 21.9% 21.4% 21.7% 26.2% 29.0% 29.9% 34.1% 34.2% 36.0% 73 1.2(a): First XlediumTerm Fiscal Policy PROJECTIONS MARCH 2002103 2003104* 2004105 2006107 2007108 2008109 Accounts Accounts <..-. __________2005106 ___.._____.___.. ~ > RupeesBillion in current prices STATE GOVERNMENT Revenue 204.6 234.1 240.4 266.1 291.0 318.9 349.4 State'sOwn Revenues 158.2 117.5 185.9 202.8 222.3 244.3 268.4 Tax 143.4 159.4 171.6 187.9 206.1 227.3 250.8 Non-Tax 14.8 18.0 14.3 14.9 16.2 17.0 17.6 Central Taxes 46.3 56.7 54.5 63.3 68.7 14.6 81.1 SharedTaxes 30.5 35.4 37.1 44.1 47.6 51.4 55.5 Grants 15.9 21.2 17.4 19.2 21.1 23.2 25.5 Xon- Interest Expenditures 233.1 228.1 255.3 212.5 285.2 306.5 326.3 Salaries (incl GIA for education) 79.8 79.6 91.5 96.1 100.6 104.9 110.3 Pensions& RetirementBenefits 33.4 32.9 45.2 52.1 53.3 58.6 62.9 Non-Wage 0 & M 21.4 24.8 27.4 29.1 31.0 33.7 37.1 Other RevenueExpenditures 0.2 0.6 0.3 0.3 0.3 0.3 0.6 SubsidiesandTransfers 75.1 65.2 57.3 59.4 57.2 59.1 61.3 Subsidies 38.6 18.6 15.9 15.3 14.7 14.2 14.2 FoodSubsidy 12.4 8.0 7.7 7.4 7.1 6.8 6.8 PowerSubsidy 22.1 0.0 0.0 0.0 0.0 0.0 0.0 Hydei SwingSubsidy 0.0 2.5 1.3 1.3 1.3 1.3 1.3 Others 2.8 6.5 7.0 6.7 6.4 6.1 6.1 Transfers 36.5 47.1 41.4 44.1 42.5 44.9 47.1 oiw Compensationto Localbodies 15.6 14.8 17.2 18.0 19.0 20.7 22.6 CapitalOutlay 20.5 21.8 29.5 32.8 39.0 46.5 50.5 Net Lending 2.6 4.4 4.2 2.7 3.8 3.3 3.5 T"PrimarySurplus(+)Ideficit (4 -28.6 5.4 -14.9 -6.4 5.8 12.5 23.1 InterestPayments 41.1 47.0 52.7 58.0 64.3 70.7 76.7 Go TN RevenueSurplus(+peficit(-) -46.5 -15.4 -33.9 -29.0 -15.7 -8.5 0.4 Go TN FiscalSurplus(+)/Deficit(-) -69.1 -41.5 -67.6 -64.4 -58.5 -58.2 -53.6 MemoItems POWER SECTOR Revenue(Excl. Power Subsidy)(I) 94.6 116.1 123.0 137.3 151.8 179.0 197.0 CashOperatingExpenditure(exci. Depreciation)(2) 100.0 109.7 112.5 124.5 138.1 154.0 170.8 EarningbeforeInt, Depm,Tax & Appropm (EBIDTA) (3)= (1)-(2) -5.4 6.3 10.5 12.8 13.8 25.0 26.1 Interest(4) 7.2 8.0 8.9 9.2 9.2 9.0 8.8 Taxation(5) 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Net LossProfit (excl. Deprn)before Subsidy(-I+) (6) -12.5 -1.7 1.6 3.6 4.6 16.0 17.3 CapitalOutlay(7) 13.9 14.8 16.0 15.3 12.3 18.0 18.0 Overall FinancingRequirementbefore Subsidy(+I-) (8) 26.4 16.5 14.4 11.7 7.6 2.0 0.7 CONSOLLDATEDACCOUNTS Revenues 291.8 347.9 361.2 401.0 440.3 495.3 543.6 Total Expenditures 312.3 402.3 440.6 414.6 504.0 553.2 596.6 RevenueExpenditure 334.8 365.0 393.5 426.4 451.4 487.8 525.8 CapitalOutlayandNetLending 37.6 37.3 47.1 48.2 52.6 65.4 70.8 ConsolidateRevenueSurplus(+)IDeficit (-) -36.9 -17.1 -32.4 -25.4 -11.1 1.5 11.1 ConsolidatedSurplus(+)IDeficit (-) (9)= (1)-(8)+(11) -74.5 -54.0 -79.4 -13.5 -63.1 -57.9 -53.0 GrossBorrowingRequirement -91.9 -90.2 -124.9 -93.2 -81.0 -18.7 -75.1 GoTN FiscalDeficit (10) -69.1 -41.5 -61.6 -64.4 -58.5 -58.2 -53.6 oiw Gross BudgetarySupportto Power (11) 21.6 3.6 2.7 2.6 2.5 2.4 1.3 PowerSubsidy 22.1 0.0 0.0 0.0 0.0 0.0 0.0 CapitalOutlay&Net Lending -0.5 3.6 2.7 2.6 2.5 2.4 1.3 Non -Power Deficits (12) =(10) +(11) -48.0 -31.9 -65.0 -61.9 -56.0 -55.9 -52.3 Debt Stockof GoTN 433.0 474.5 542.3 595.2 648.9 707.1 160.1 Guarantees 91.9 108.2 94.2 99.2 104.2 109.2 114.2 GoTNDebtand Guarantees 524.9 582.1 636.5 694.4 753.1 816.3 874.9 * PowerSectorNumbersfor 2003104are forecasts from thebusinessplan In2003104the actualconsolidatedfiscal andrevenuedeficitare higherby Rs. 10bn accordingto the Govemment.Since detailsare not availablethis havenot beenincorporatedin this table. The actual consolidatedfiscal deficit in2003104is 3.8% ofGSDP. 74