Report No: 95979 - IN INDIA DEVELOPMENT UPDATE Towards a higher growth path April 2015 Macroeconomics & Fiscal Management INDIAA DEVE ELOPM MENT U E UPDATE ds a high Toward th path her growt April 2015 Macroeconomics & Fiscal Management © 2014 International Bank for Reconstruction and Development / The World Bank 1818 H Street NW Washington DC 20433 Telephone: 202-473-1000 Internet: www.worldbank.org Standard Disclaimer: This work is a product of the staff of The World Bank with external contributions. The findings, interpretations, and conclusions expressed in this work do not necessarily reflect the views of The World Bank, its Board of Executive Directors, or the governments they represent. The World Bank does not guarantee the accuracy of the data included in this work. 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Photo Credits: Cover: ©Flickr.com/Ramnath Bhat, pp. 1: ©Flickr.com/NASA’s Marshall Space Flight Center, pp. 35: ©Flickr.com/Mr Thinktank, pp. 41: ©Flickr.com/World Bank Photo Collection Photographs used in this report are available under the Creative Commons Attribution 2.0 Generic (CC by 2.0) https://creativecommons.org/licenses/by/2.0/ Preface The India Development Update has two main aims. First, it reports on the key developments over the past six months in India’s economy, and places these in a longer term and global context. Based on these developments and on policy changes over the period, it updates the outlook for India’s economy and social welfare. Second, the Update provides a more in-depth examination of selected economic and policy issues, and analysis of medium-term development challenges. It is intended for a wide audience, including policymakers, business leaders, financial market participants, and the community of analysts and professionals engaged in India’s evolving economy. This Update was prepared by Poonam Gupta (DEC), Frederico Gil Sander, Smriti Seth, Saurabh Shome, and Jaba Misra (GMFDR) under the guidance of Shubham Chaudhuri (Practice Manager, GMFDR); Neeti Katoch (GFMDR) authored the financial sector analysis, Shrayana Bhattacharya and Rinku Murgai (GPVDR) authored the section on MGNREGS. Valuable inputs from Tehmina Khan, Marc Stoker, Supriyo De (DECPG), Anuradha Ray and Varsha Marathe Dayal (GFMDR); and discussions and suggestions from Denis Medvedev are gratefully acknowledged. Poonam Gupta acknowledges timely and diligent help on the data and charts from Serhat Solmaz (DEC). Onno Ruhl (Country Director, SACIN), Satu Kahkonen (Director, GMFDR) and Marcelo Giugale (Senior Director, GMFDR) provided overall strategic direction and guidance to the team. Table of contents EXECUTIVE SUMMARY .................................................................................................................... I 1. The government has announced ambitious development goals and concerted reform measures in encompassing areas ........................................................................................................ I 2. The economy seems to have turned the corner, and the economic outlook has improved significantly ......................................................................................................................... I 3. There are external as well as domestic risks to the outlook ........................................................ II A. RECENT ECONOMIC DEVELOPMENT AND OUTLOOK ..................................................... 1 1. Real Sector Activity ....................................................................................................................... 1 2. Private Sector Investment ............................................................................................................. 3 3. Financial Sector Issues ................................................................................................................. 7 4. Inflation ......................................................................................................................................... 9 5. Monetary Policy ...........................................................................................................................12 6. Fiscal Developments and Union Budget .....................................................................................14 7. Balance of Payment......................................................................................................................19 8. Global Developments .................................................................................................................. 25 9. Outlook and Projections ............................................................................................................. 29 a. Near-term outlook is positive on renewed reform momentum ........................................... 29 b. There are substantial external as well as domestic risks to the outlook ............................. 33 B.SELECTED ISSUES ....................................................................................................................... 35 1. Decline in Oil Prices and Opportunities for India ...................................................................... 35 a. India has benefitted on several fronts from the decline in global crude prices .................. 36 b. Decline in oil prices helped generate important fiscal and current account savings; but the opportunity could be seized to deepen price and subsidy reforms and generate durable policy buffers ........................................................................................................................... 40 2. Is MGNREGS cost-effective against poverty? .............................................................................41 a. The Promise of Workfare......................................................................................................41 b. Debates about MGNREGS ................................................................................................. 42 c. Performance of MGNREGS: Explaining the Gap between Potential and Practice ........... 43 d. Stacking-up MGNREGS against a Cash Transfer .............................................................. 45 e. Two Directions for Reform.................................................................................................. 46 REFERENCES ................................................................................................................................... 48 ANNEX: REFORM MEASURES....................................................................................................... 49 APPENDIX: India Economic outlook in a cross country perspective .......................................... 55 LIST OF FIGURES Figure 1: GDP Growth Accelerated in 2014-15, with the Service Sector making the largest Contribution ........................................................................................................................ 2 Figure 2: Private and Public Consumption contributed primarily to GDP Growth in 2014-15, while Contribution from Investment and Exports Remained Subdued ...................................... 3 Figure 3: After Increasing Impressively in the mid-2000s, Savings and Investment Ratios have declined, and Rebound is not yet in Sight (data for fiscal years) ....................................... 3 Figure 4: The Rate of Growth of Private and Public investment seem Weakly Correlated, implying the “Crowding in” is perhaps not very Strong .................................................................... 5 Figure 5: Gross Non Performing Loans as a percentage of Gross Advances increased; Non Performing Loans are higher in the Public Sector Banks................................................... 7 Figure 6: Deposit and Credit Growth remains Subdued across Banks, particularly in the Public Sector Banks ........................................................................................................................ 7 Figure 7: Moderation in Inflation (yoy) was broad based, seen in CPI, WPI; Food, and Fuel Inflation ............................................................................................................................... 9 Figure 8: Decline in Food and Beverages Inflation, primarily Contributed to the decline in Inflation in 2014-15 .............................................................................................................10 Figure 9: Several Domestic and Global Factors Contributed to Moderating Inflation in India .....10 Figure 10: Inflation has been simultaneously declining globally, including in major emerging economies; partly driven by the global decline in the oil and commodity prices.............. 11 Figure 11: Exchange rate depreciation was much lower in 2014-15, (some appreciation was seen in the past few months) further abating inflationary pressures ............................................. 11 Figure 12: Inflation calculated using old and revised series of CPI Track each other quite closely ............................................................................................................................................12 Figure 13: Monetary Policy was Accommodative in the Last Quarter of Fiscal Year, 2014-15 ........13 Figure 14: Revised Estimates for Tax Revenue in 2014-15 are lower than Budgeted, necessitating Expenditure Compression to meet the Fiscal Deficit Target ............................................14 Figure 15: While Revenue outturns are expected to be lower than budgeted in 2014-15, Subsidies overshot marginally ............................................................................................................15 Figure 16: Fiscal Deficit Outturns and the Glide Path of Deficit in the Years Ahead.....................15 Figure 17: Center to devolve a Larger Share to the States; Lower Current Expenditure, including Fuel Subsidies, while restoring Capital Expenditure ........................................................16 Figure 18: Revenue Projections for 2015-16 seem optimistic compared to the past Two Years ......17 Figure 19: Disinvestment Receipts have often been less than Budgeted in the Past ......................17 Figure 20: Change in the Distribution of Tax Revenue across States in the Fourteenth Finance Commission, over the Thirteenth Finance Commission ...................................................19 Figure 21: Decline in the Value of Oil Import helped restrain Trade Deficit and the Current Account Deficit ................................................................................................................. 20 Figure 22: Services Exports and Remittances Increased at a Steady Pace; while Merchandise Exports Stagnated ..............................................................................................................21 Figure 23: FDI inflows, and Portfolio inflows were Robust in 2014-15; but over the longer term while FDI Flows were relatively Stable, Portfolio Flows and Bank Flows Exhibited Volatility .............................................................................................................................21 Figure 24: While Nominal Exchange Rate was broadly stable, the Real Exchange Rate Appreciated ....................................................................................................................... 22 Figure 25: International Reserves Increased Providing a Buffer against External Vulnerability .. 23 Figure 26: Gold Imports Correlate Positively with Domestic Inflation and With the International Price of Gold...................................................................................................................... 23 Figure 27: Along with the Import of Gold, Exports of Gems and Jewelry have Moderated Recently ........................................................................................................................................... 24 Figure 28: Global Growth Remains Soft ......................................................................................... 25 Figure 29: Growth remains subdued in India’s Major Trading Partners, as well in its Peers........ 26 Figure 30: Global inflation is reigning low and Monetary Policy has Been Accommodative in Advanced and Emerging Economies ............................................................................... 27 Figure 31: Remittances picked up in mid 2000s to grow at 15 percent annually; Contributing Significantly to the Balance of Payments.......................................................................... 29 Figure 32: GDP Growth Forecast—Gradual Acceleration to Continue assuming Reforms Succeed in Unlocking Private investment....................................................................................... 30 Figure 33: Growth momentum declined in the third quarter ......................................................... 30 Figure 34: GDP Growth Forecast is underpinned by Investment picking up, aided by Consumption Growth; Industrial growth would be crucial for Growth Acceleration .......31 Figure 35: Growth prospects of the world trade are subdued. After increasing far more rapidly than the global GDP until 2007, global trade has been growing at a slower pace than before................................................................................................................................. 32 Figure 36: International oil price has declined sharply since mid-2014 and is reflected in a decline in the import price of Indian oil Basket ............................................................................ 36 Figure 37: India Imports Crude Oil and Exports Refined Oil and runs a Significant Trade Deficit on Petroleum Products; the Trade Deficit has declined due to the decline in oil prices . 37 Figure 38: After Increasing Impressively in the mid-2000s, Savings and Investment Ratios have declined, and Rebound is not yet in Sight ........................................................................ 38 Figure 39: Retail prices of Petrol and Diesel Correlate with the Import price; but Kerosene and LPG prices do not ............................................................................................................. 39 Figure 40: Demand for MGNREGS work is greater in poorer states, but participation rates are not ..................................................................................................................................... 44 LIST OF TABLES Table 1: Projects referred to the Project Monitoring Group (PMG) and Resolved .......................... 5 Table 2: Correlates of Growth in Private Investment ....................................................................... 6 Table 3: Central Assistance to State Plans has been restructured to partially compensate for the increased tax devolution to the States ................................................................................16 Table 4: Recommended Criteria for Horizontal Devolution of Tax Revenue among States ..........18 Table 5: Import Restrictive Measures on the Import of Gold ........................................................ 24 LIST OF BOXES Box 1: Recent announcements pertaining to the financial sector Recent announcements pertaining to the financial sector ........................................................................................... 8 Box 2: Revision in the CPI series.....................................................................................................12 Box 3: Recommendation of the fourteenth finance commission ....................................................18 Box 4: Recent development in gold imports .................................................................................. 23 Box 5: Remittances to India-Robust growth and resilience to domestic and external shocks ...... 28 LIST OF APPENDIX FIGURES Appendix Figure 1: India is a large economy and… ...................................................................... 55 Appendix Figure 2: …One of the fastest growing economy .......................................................... 55 Appendix Figure 3: Inflation has declined, Fiscal deficit has declined, and growth has accelerated…. .................................................................................................................... 55 Appendix Figure 4: …and current account deficit has declined, foreign direct and portfolio investment has increased, and accumulation of external reserves has increased ........................................................................................................................... 55 Appendix Figure 5: Inflation is still on the higher side…. ............................................................. 56 Appendix Figure 6: ….as is the fiscal deficit .................................................................................. 56 Appendix Figure 7: Share of manufacturing in GDP is low… ....................................................... 56 Appendix Figure 8: …and has been growing at a modest rate ...................................................... 56 Appendix Figure 9: Exports growth (merchandise) has been slow…............................................ 57 Appendix Figure 10: ….and its share in World Exports is low ....................................................... 57 Appendix Figure 11: ….and its share in World Exports is low Credit to GDP ratio has been low… ........................................................................................................................................... 57 Appendix Figure 12: ….and its share in World Exports is low ….and has been growing slowly .. 57 Appendix Figure 13: Rate of Investment is comparable…. ............................................................ 57 Appendix Figure 14: ….but has been growing slowly .................................................................... 57 LIST OF APPENDIX TABLES Appendix Table 1: Selected Economic Indicators.......................................................................... 58 Appendix Table 2: Central Government Finances ......................................................................... 59 Appendix Table 3: Development Indicators................................................................................... 60 Towards a higher growth path India Development Update Executive summary 1. The government has announced ambitious development goals and concerted reform measures in encompassing areas After a decisive The development agenda, described in the annual budget as “vision 2022”, seeks to election victory in ensure employment, economic opportunity, housing, electricity, water, sanitation, May 2014, the connectivity, medical facility and schools for all its people by 2022, the 75th year of government has set India’s independence. A three pronged strategy underpins this vision--fast and ambitious durable economic growth, especially in manufacturing, supported by a stable development goals, macroeconomic environment; involving the States as active development partners in seeking to transform a move toward “cooperative and competitive federalism”; and improving the India into a delivery of social benefits while extending the social safety coverage to the elderly, “prosperous” nation and the underprivileged. The government has Reforms include efforts to improve the business environment; liberalization of FDI; started enhancing investment in infrastructure; speedier resolution of corporate disputes; implementing and simplified and lower corporate taxation. It has devolved more resources and reforms spanning a spending discretion to the States in the Budget for 2015-16; free up some fiscal number of areas to space through fuel tax and subsidy reforms; and strove to improve the quality of achieve these goals public expenditure. The government reiterated its resolve to implement the GST by April, 2016, widely expected to increase India’s tax-to-GDP ratio by at least a couple of percentage points. Some progress has been made on weaning the delivery of social benefits from price based subsidies and in-kind transfers toward direct transfer of benefits. The new models of delivery, to be channeled through bank accounts, mobile phones, and the biometric identity of the beneficiaries, are expected to improve targeting and reduce inefficiencies and leakages. Commensurately, 125 million bank accounts have been opened in a short span of time; while the coverage of the biometric based Unique Identification is being extended to cover the entire population. 2. The economy seems to have turned the corner, and the economic outlook has improved significantly Aided by a The economy has been on an upturn in the last three quarters--growth has supportive external accelerated, inflation has declined, current account deficit has narrowed, and environment, in external buffers have been replenished. GDP growth (at market prices) is projected particular the sharp to accelerate to 7.2 percent in 2014-15, compared to 6.9 percent in the previous decline in oil and year. On the production side, growth is driven by the services sector, which commodity prices, continues to outperform manufacturing; and on the expenditure side, it is driven by the economy has public and private consumption, with modest contributions from investment and taken strong strides exports. Underpinned by the global trends, inflation declined to 4.6 percent during towards higher the second half of 2014-15 from an average of 7.3 percent in the first half of the growth and year. The decline in inflation and fiscal restraint generated some room for monetary enhanced stability accommodation, making it possible for the RBI to lower the policy rates twice in the last quarter of 2014-15. The fiscal deficit The deficit target for 2014-15 is likely to be met despite weak revenue collection, target of 4.1 percent primarily by compressing current and capital expenditure. Deviating from recent of GDP in 2014-15 is trends, the recently announced budget for 2015-16 proposed to improve the quality April 2015 THE WORLD BANK I Towards a higher growth path India Development Update expected to be met; of expenditure by increasing capital expenditure by about 0.2 percent of GDP next followed by a modest year; while allocating a larger share of tax revenue to the States, along with greater consolidation in spending discretion. There was some decline in fuel subsidies, due to subsidy 2015-16 reforms as well as the decline in the price of oil. Meeting the budgeted fiscal targets for 2015-16 would depend on the realization of tax buoyancy assumed in the budget, as well as the targets for disinvestment receipts, and the assumptions on oil prices and growth outcomes. The government slowed down the pace of medium term fiscal consolidation to make room for “funding infrastructure investment”, proposing to consolidate the deficit to 3 percent of GDP in the next three years, instead of two as was proposed in the previous budget; setting the glide path of deficit to 3.9 percent, 3.5 percent and 3.0 percent respectively in 2015-16, 2016-17 and 2017-18. Balance of payment While the decline in the price of oil helped contain the oil import bill; moderation in outlook improved the price of gold and restrictions on gold imports helped restrain the import of gold. during the year Both these developments restrained the trade deficit to $112 billion in the first three quarters of 2014-15, compared to $117 billion over the same period in the previous fiscal year. With the steady stream of remittances and services exports, the current account deficit was curtailed at $26 billion in the first three quarters of the fiscal year, compared to $31 billion over the same period in the previous year. The RBI refurbished its reserve buffers, increasing it by nearly $40 billion during the year to $338 billion as of February 27, 2015. GDP growth (at Acceleration in growth is conditional on the rate of investment picking up to 11 market prices) is percent during FY2016-FY2018. 2 Pace of growth of government consumption expected to expenditure is expected to increase in 2015-16 on account of the anticipated accelerate to 7.5 revision in public salaries under the ambit of the 7th Pay Commission; and private percent in 2015-16 consumption expenditure is expected to respond gradually, increasing to 9 percent reaching 8.0 percent by 2017-18 from 6.1 percent in 2014-15. Low crude prices, improved production in 2017-181 capacity, and the adoption of the flexible inflation targeting framework, would likely keep inflationary pressures under check, inflationary expectations anchored and help prevent overheating in the medium-term. Global growth Global growth is expected to pick-up modestly this year, but less than previously remains contained, anticipated. Several countries and regions with strong trade, diaspora and marred by below investment links with India continue to face a soft growth patch, dampening the average growth in external outlook. Countries that figure most prominently among large destinations crucial economic for Indian exports as well as its diaspora, such as the UAE, Saudi Arabia, the partners of India broader set of GCC, but also China and Europe, face subdued growth prospects. These could translate into some slowdown in remittances, and possibly in FDI flows into India, while undermining the prospects for resurgence in exports growth. 3. There are external as well as domestic risks to the outlook The recent economic The current economic narrative, described in the Economic Survey as India being in turnaround and the a “sweet spot”, characterized by decline in inflation; and current account deficit; and outlook rest crucially fiscal restraint, derives partly from the recent sharp decline in the international on oil and prices of oil, metals and food. This narrative could alter if prices fail to stay low, commodity prices reinforcing the imperative for the government to insulate the economy even more 1 Forecasts are made using the revised (base year: 2011-12) national accounts series. The official series only goes back till 2011-12, we back-casted the series to 1960 using growth rates. 2 FY2016 refers to the fiscal year ending 31st March 2016. April 2015 THE WORLD BANK II Towards a higher growth path India Development Update remaining low determinedly from the global price of oil. This could be done by weaning the fiscal outcomes more fully from oil prices; by reducing the intensity of use of imported oil, while encouraging alternative sources of energy; by mulling the possibility of creating additional fiscal buffers by using petroleum taxation more actively, as well as by appropriating the current sweet spot moment to further rationalize the still high levels of subsidies on food and fertilizer. India remains at risk Even though the Federal Reserve Board has continued to maintain its stance on of disruptive impact monetary policy, the expectations are that it would start the tightening phase on its exchange rate sometime soon, and possibly as early as in summer, 2015. India being one of the and financial larger financial markets and a large recipient of capital flows, could be adversely markets from affected by a rebalancing triggered by the tightening of the Fed’s monetary policy.3 potential tightening While the Reserve Bank of India has taken preventive measures to reduce external of the US monetary vulnerability, and has built international buffers as a “first line of defense”; the risk policy remains, warranting vigilance. With the potential for On the supply side, Indian merchandise exports have not been able to keep pace rapid export growth with the growth in world exports in the past, reflected in the share of Indian exports constrained by both in world exports remaining stagnant. On the demand side, the share of world supply and demand exports to world GDP seems to have peaked. It would take a level increase in the conditions in near competitiveness of Indian manufacturing for it to carve a space for itself among the term, the case for existing large exporters, within a market that seems to have peaked out. Among the structural reforms many preconditions for India to improve its competitiveness are an infrastructural and stepping up boost to bring it at par with the current manufacturing hubs in the world; infrastructure is even competitive supply of all factor inputs, such as labor, land, finance, and skills; and a more compelling competitive business environment. Amidst thin fiscal With a stubbornly low tax-to-GDP ratio, alternative channels of long term space, there is investment need to be explored while reviving the PPP model of financing to meet limited scope for India’s yawning infrastructure gap. Simultaneous efforts to increase the tax-to-GDP public investment to ratios, through the timely implementation of the GST, as well as complimentary help bridge the measures to improve tax administration and compliance could generate additional infrastructure deficit; fiscal space in the years ahead. The outlook for new investments continues to be unlocking private dented by the debt overhang in the corporate balance sheets, which has extended to investment would be the Public Sector Banks (PSB). The banks’ balance sheets are currently marred by crucial high Non-Performing Loans, low profitability, and subdued credit growth, and may not be able to support higher demand for credit if the investment cycle were to turn around. While some measures have been announced to strengthen the balance sheets of the PSBs and to improve their operational efficiency, more decisive measures would be needed given the underlying magnitude of the recapitalization requirement and other medium term ownership related issues. The pace of reforms The government has embarked on energetic progress in several policy areas. The would need to be pace of these efforts would need to be maintained or even stepped up to unleash maintained or even the productivity and scale enhancement needed for the Indian firms to become stepped up to meet globally competitive. As has been suggested elsewhere, devolving more policy space the development to the states may produce enclaves of competitiveness and help garner further objectives support for wider reforms among the population and political classes across India. 3 See Eichengreen, Barry and Gupta, Poonam, 2014, “Tapering talk: the impact of expectations of reduced Federal Reserve security purchases on emerging markets”, Policy Research Working Paper 6754, The World Bank. April 2015 THE WORLD BANK III Towards a higher growth path India Development Update R A. Recent E mic De Econom ment a evelopm and Ou tlook al Sector Activity 1. Rea Economi ic activity GDP grow wth (at market elerated to 7.4 t prices) acce 4 percent dur ring the first three ened in 2014- quarters of 2014-15, com strengthe mpared to 7 peercent during t the same perio On the od last year. O 15 production side, the services sector,, accounting for nearly h half of total GDP, continued to be the la butor to economic growt argest contrib th, with a di istinct n in growth in acceleration n the second aand third quar 15, to 10.1 and rter of 2014-1 d 13.5 percent res gure 1). With spectively (Fig hin services, growth was driven by a sharp n in public adm acceleration and defense (g ministration a growing at 200 percent yoy in the third quarteer, compared to an averag ge growth of f 4 percent du uring the firsst two a well as the quarters), as e continued b buoyancy in f ices and real estate financial servi owth of 13.8 percent services (gro p n the first thre yoy) in f 2014-15. ee quarters of April 2015 THE WORLD BANK 1 Towards a higher growth path India Development Update Figure 1: GDP Growth Accelerated in 2014-15, with the Service Sector making the largest Contribution (percent change, yoy) Contribution to GDP Growth 9 GDP Growth percent Change - Year to Year Agriculture and allied Industry Services 8 percent Change - Year to Year 8 7 7 6 6 5 4 5 3 4 2 1 3 0 Q1 2012-13 Q2 2012-13 Q3 2012-13 Q4 2012-13 Q1 2013-14 Q2 2013-14 Q3 2013-14 Q4 2013-14 Q1 2014-15 Q2 2014-15 Q3 2014-15 -1 Q1 2012-13 Q2 2012-13 Q3 2012-13 Q4 2012-13 Q1 2013-14 Q2 2013-14 Q3 2013-14 Q4 2013-14 Q1 2014-15 Q2 2014-15 Q3 2014-15 Source: Central Statistical Office, India Industrial Industrial output, which accounts for nearly one-third of GDP, accelerated by 5.3 production revived percent during the first three quarters of 2014-15, compared to 4.6 percent last year, during 2014-15 and 2.7 percent in the year before. The manufacturing sector (with a weight of 18 percent in GDP) grew at a steady 5.4 percent in the first three quarters of the fiscal year. The trend of revival was also reflected in high frequency indicators of industrial production—the Index of Industrial Production, grew by 2.6 percent yoy during Apr-Dec 2014, from stagnant output in the previous year. While utilities grew at a robust 9.6 percent during Apr-Dec, 2014, construction growth slowed in the third quarter of 2014-15. Agriculture output Agriculture output growth continued to decelerate (growth turned negative in the growth continued to third quarter, yoy) due to deficient rainfall. Growth in agricultural output decelerate in 2014-15 decelerated during the first three quarters 2014-15 to 1.4 percent from 3.4 percent last year, due to below-normal rainfall during the monsoon season. Total food-grain production during the kharif (summer) season – which accounts for more than one- third of total agricultural output was 3 percent below the level in previous year. The decline is largely attributed to deficient rainfall (53 percent of the gross cropped is rain-fed) which affected the production of rice, coarse cereals and pulses. On the expenditure Private final consumption expenditure (which accounts for close to 60 percent of side, consumption total demand for output) grew at average 6.5 percent yoy during the first two growth, at 6.2 quarters of 2014-15, but decelerated to 3.5 percent in the third quarter (Figure 2). percent in the first This deceleration was in-turn countered by a 32 percent spike in public three quarters of consumption expenditure in the third quarter. In 2014-15 government consumption 2014-15, was most was a major contributor to growth. Simultaneously, fixed capital formation robust (investment), after growing rapidly in the first quarter at 7.7 percent, lost momentum in the next two quarters, growing at an average 2.2 percent. Exports growth has been worryingly negative in the second and third quarters of 2014-15, the growth in three quarters averaging at a low 0.5 percent. Low exports growth was on account of the decline in petroleum exports, and stagnant exports of gems and jewelry, which together account for one third of the export basket; but also due to slow exports growth of other products. April 2015 THE WORLD BANK 2 Towards a higher growth path India Development Update Figure 2: Private and Public Consumption contributed primarily to GDP Growth in 2014-15, while Contribution from Investment and Exports Remained Subdued (percent contributions, yoy) Final Consumption Expenditure: Private Gross Fixed Capital Formation Final Consumption Expenditure: Government Exports of Goods and Services 10 8 6 5 4 2 0 0 -2 -5 Q1 2012-13 Q2 2012-13 Q3 2012-13 Q4 2012-13 Q1 2013-14 Q2 2013-14 Q3 2013-14 Q4 2013-14 Q1 2014-15 Q2 2014-15 Q3 2014-15 Q1 2012-13 Q2 2012-13 Q3 2012-13 Q4 2012-13 Q1 2013-14 Q2 2013-14 Q3 2013-14 Q4 2013-14 Q1 2014-15 Q2 2014-15 Q3 2014-15 Source: Central Statistical Office, India 2. Private Sector Investment Investment’s Private investment in particular remained subdued, compared to the other drivers of contribution to GDP growth, as well as to its own past performance. The weak investment growth is growth was modest attributed to a combination of factors, as discussed aptly in the Economic Survey, in 2014-15 “weak corporate balance sheets, an impaired banking system, difficulty of exit, the deficiencies of the public private partnership (PPP) model in infrastructure—could hold back private investment going forward”. Figure 3: After Increasing Impressively in the mid-2000s, Savings and Investment Ratios have declined, and Rebound is not yet in Sight (data for fiscal years) Saving and Investment Rate Private and Public Investment Gross Domestic Savings Public Sector Private sector Gross Capital Formation 30 40 25 35 20 % of GDP % of GDP 30 15 25 10 20 5 15 0 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 Source: Central Statistical Office, India Slowdown in As discussed in the Economic Survey, the decline in the rate of investment has investment is evident extended to all major sectors of the economy--agriculture, manufacturing, across all sectors of construction, other non-industrial sectors, as well as services. For example, in the economy construction activities, the rate of capital formation declined from 6.5 percent in 2011-12 to 5.5 percent in 2013-14; translating in to an annual decline in investment of 11.5 percent in 2012-13; and a further decline of 4.4 percent in 2013-14 (Figure April 2015 THE WORLD BANK 3 Towards a higher growth path India Development Update 3). The construction sector has also been affected by a decline in the FDI in recent years, annual FDI flows declined by 8 percent in 2013-14 and by 2 percent in April- November 2014-15. Just like the other sectors, the investment outlook in the construction sector, has been dented by issues related to the prevailing PPP models, and stretched balance sheets in the banking sector. The current situation is considered precarious in which some developers find it challenging to even meet their working capital needs.4 A large number of Private sector has a high rate of stalling, with about 16 percent of its projects under private sector implementation currently held up. While a large number of projects are held up in projects are currently the infrastructure sector, particularly in electricity, projects are also held up in other stalled, with sectors, including manufacturing. The main reasons for stalled projects are investment worth 7 considered to be poor market conditions, lack of promoter interest and inability to percent of GDP acquire timely regulatory clearances for private sector projects; government projects locked up in these seem to be held up due to issues related to land acquisition, lack of funds and lack projects of timely regulatory clearances. The government has The government has set up a Project Monitoring Group (PMG) to track stalled set up a Project projects and to remove their implementation bottlenecks. Project involving Monitoring Group to investments of INR 10 billion or more, or any project in sectors such as track stalled projects infrastructure, manufacturing, power, etc. can be referred to the Group for and to remove their resolution. The PMG has already been successful in resolving more than 200 of the implementation projects referred to it, worth nearly 30 percent of the value of all projects (Table 1). bottlenecks The government has Authorities proposed to introduce a Public Contracts (Resolution of Disputes) Bill announced several to streamline the institutional arrangements for the resolution of disputes in public additional measures contracts; as well as to set up exclusive commercial divisions in various courts for to ease regulatory faster resolution of commercial disputes. The government has sought to increase constraints on investment in infrastructure by the public sector, specifically in roads and railways, private investment in order to “crowd in” private investment. The allocation in the budget for and to step up public infrastructure investment by the public sector is estimated at INR 700 billion. investment in order Besides, to encourage greater private sector financing in infrastructure, the budget to catalyze private has announced tax free bonds to raise funds for railways, roads and irrigation investment projects; plans to revive the PPP model to encourage greater private sector participation in large infrastructure projects; and corporatization of public sector ports and their conversion into companies under the Company’s Act, to attract investments therein. 4Recently the norms related to minimum land area, capitalization, and repatriation of funds for FDI in construction development projects have been liberalized (Economic Survey, 2015). April 2015 THE WORLD BANK 4 Towards a higher growth path India Development Update Table 1: Projects referred to the Project Monitoring Group (PMG) and Resolved (Amount in INR 10 million) Number of Projects Total Value of the Number of Projects Total Value of the Referred Projects Referred Resolved Projects Resolved Power 200 1,107,138 103 460,140 Coal 77 127,856 30 12,674 Steel 51 509,116 7 40,296 Petroleum and Natural 48 370,709 19 44,425 gas Roadways 41 59,070 15 20,410 Railways 26 51,994 10 26,045 Commerce and 20 37,315 4 14,200 industry-DIPP Shipping 19 38,787 8 1,008 Commerce and 9 54,285 2 10,000 industry-Commerce Mines 8 51,208 4 24,205 Chemical and 3 19,178 0 0 Fertilizers Civil Aviation 2 24,000 2 24,000 Textiles 1 1285 1 1,285 Petrochemicals 1 9000 0 0 Total of above 506 2,460,941 205 688,687 Source: Project Monitoring Group, Cabinet Secretariat, Government of India The correlation Looking at past two Figure 4: The Rate of Growth of Private and Public between public decades of data on investment seem Weakly Correlated, implying the investment on private investment and “Crowding in” is perhaps not very Strong private investment public investment, two Investment Growth has not been very observations stand out. Public Sector Private sector strong in the past, First, the size of private 100 indicating that the investment is much % Change - Year to Year 80 crowding in effect larger compared to may not be very public investment; 60 strong going second, private and 40 forward public investment 20 growth seem to have their own trajectories 0 quite unrelated to each -20 other (Figure 4). This -40 “disconnect” is borne 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 out in a simple analysis of the correlates of the Source: Central Statistical Office, India private investment growth in Table 2 below. Regressing annual growth in private investment on one or two lags of the growth of public investment, or GDP growth; estimates show that the private investment has not correlated strongly with public investment; even though its correlation with GDP growth is high. One possible interpretation of these results is that private investment has been more responsive to market conditions, while the “crowding in” impact from public investment has been weak. April 2015 THE WORLD BANK 5 Towards a higher growth path India Development Update Table 2: Correlates of Growth in Private Investment (Dependent variable: percent growth in private investment) Independent Variables (1) (2) (3) (4) Growth in Public Investment, lag1 0.26 0.44 [0.63] [1.03] Growth in Public Investment, lag2 -0.51 [1.16] Growth in GDP, lag1 3.16*** 3.51*** [3.32] [3.51] Growth in GDP, lag2 -1.49 [1.56] Constant 9.15** 11.11** -9.98 -2.47 [2.29] [2.42] [1.36] [0.32] Observations 22 22 22 22 R-squared 0.02 0.08 0.25 0.30 Adj. R-squared -0.03 -0.02 0.21 0.23 Note: Data are annual for 1993-2014. Regressions are estimated by Ordinary Least Squares. Source: Central Statistical Office and World Bank Staff calculations With the fiscal space Unlocking private investment, especially in manufacturing, would be critical to running thin, there support higher growth and exports buoyancy. With a stubbornly low tax-to-GDP may be limited room ratio, alternative channels of long term investment need to be explored while for public investment reviving the PPP model of financing to meet India’s yawning infrastructure gap. to help bridge Simultaneous efforts to increase the tax-to-GDP ratios, through the timely India’s infrastructure implementation of the GST, as well as complimentary measures to improve tax deficit administration and compliance would generate additional fiscal space in the years ahead. Debt overhang in The outlook for new investments continues to be dented by the debt overhang in corporate balance the corporate balance sheets, which has extended to the Public Sector Banks (PSB). sheets, extending to The banks’ balance sheets are currently marred by high Non-Performing Loans, low the public sector profitability, and subdued credit growth, and may not be able to support higher banks, as well as to demand for credit if the investment cycle were to turn around. While some the public sector, measures have been announced to strengthen the balance sheets of the PSBs and to further weighs on the improve their operational efficiency, more decisive measures would be needed given outlook for the underlying magnitude of the recapitalization requirement and other medium investment term ownership related issues. 3. Financial Sector Issues The outlook for Gross Non-Performing Advances (GNPA) of Scheduled Commercial Banks Indian banks (SCBs), as a percentage of total gross advances, increased to 4.5 percent in continues to be September 2014 from 4.1 per cent in March 2014, and 3.2 percent in March 2013 weighed down by (Figure 5). 5 Simultaneously, stressed advances increased to 10.7 per cent of the total high non-performing advances in September 2014 from 10.0 per cent in March 2014. Public Sector Banks loans (PSBs) continue to record higher level of Non-Performing Loans as well as stressed assets (at 12.9 percent of their total advances as compared to 10.7 percent for all commercial banks). Within the PSBs, the SBI and affiliated banks bear the highest 5Gross non-performing advances are the loan assets that are classified as non-performing as per the RBI’s guidelines; GNPAs are gross of provisions regarding NPAs. April 2015 THE WORLD BANK 6 Towards a higher growth path India Development Update ratio of non-performing assets, possibly due to their higher exposure to large infrastructure loans (infrastructure, iron and steel, aviation, and mining together accounted for over half of total stressed assets as of December 2014). Amidst deteriorated balance sheets, provision coverage ratio declined from 71.4 percent to 53.7 percent from March 2014 to September 2014, below the RBI’s benchmark of 75 percent. Figure 5: Gross Non Performing Loans as a percentage of Gross Advances increased; Non Performing Loans are higher in the Public Sector Banks Gross NPAs to Gross Advances Gross NPAs to Gross Advances June 2014 Scheduled Commercial Banks 6 Public Sector Banks 5.5% 5 5.0% 4 3 % 4.5% 2 4.0% 1 3.5% 0 New Private Nationalised SBI group Old private banks All banks 3.0% Banks banks 2.5% 2.0% FY11 FY12 FY13 FY14 H1 FY15 Source: Reserve Bank of India Credit growth Credit growth at 10.1 percent, yoy, in December 2014 remained lower than the 14.2 remained sluggish, percent recorded in the previous year (Figure 6). Though a slight improvement over reflecting risk 9.5 percent growth yoy in September 2014, it is not certain whether the increase aversion and weak would prove to be durable. The slowdown is largely attributed to slow credit growth balance sheets of in the PSBs, which focused more on recovery given their weak balance sheets. banks Deposits growth declined as well, to 10.9 percent in December 2014 from 12.3 per cent as of September 2014 and 15.4 percent in December 2013. Banks’ profitability remains under pressure due to higher delinquency requirements and slowdown of credit growth. Figure 6: Deposit and Credit Growth remains Subdued across Banks, particularly in the Public Sector Banks Deposit growth Credit growth SBI and its Associates Nationalised Banks SBI and its Associates Nationalised Banks Private Banks Private Banks 25 25 20 20 15 15 10 10 5 5 0 0 Dec-2013 Dec-2014 Dec-2011 Dec-2012 Mar-2014 Jun-2014 Mar-2012 Jun-2012 Mar-2013 Jun-2013 Sep-2012 Sep-2013 Sep-2014 Mar-2012 Mar-2013 Mar-2014 Dec-2011 Dec-2012 Dec-2013 Dec-2014 Jun-2012 Sep-2012 Jun-2013 Sep-2013 Jun-2014 Sep-2014 Source: Reserve Bank of India April 2015 THE WORLD BANK 7 Towards a higher growth path India Development Update The Government With the high non-performing loan ratios, and the imperative to follow Basel III considered ways to norms and bolster capital to sustain credit growth at levels that support the raise additional economy adequately, India’s public sector banks are likely to face a shortfall of capital for banks capital.6 The government has announced some measures to augment their facing asset quality capitalization. The banks have been allowed to reduce government’s share in equity issues amidst sizable to 52 percent in a phased manner. However, given their current valuations, short capital needs and term divestment is unlikely to takeoff in near term, nor fiscally optimal without high financing costs efforts to bolster valuations. The government has announced a new criterion for determining banks’ eligibility for capital infusion by the government. The new criterion, announced in February 2015, takes into consideration the past performance of the bank and requires that its Return on Assets must exceed the average of all PSBs for the past three years, and its Return on Equity must be higher than the average, for the past one year. As per this criterion, only nine PSBs were found eligible to receive equity from the government; and would receive altogether INR 69.9 billion in 2015-16.7 Box 1: Recent announcements pertaining to the financial sector Recognizing the need to strengthen the balance sheets of public sector banks and to improve their operational efficiency so that they could compete with private banks and play an active role in supporting economic growth, the government held a two-day retreat with the top management of banks and financial institutions in January, 2015. Discussions focused on enhancing the functional autonomy of the PSBs, and on improving their governance structure (some of the discussion modeled on the recommendation of the P J Nayak Committee report). Several measures were announced during the year to strengthen the financial sector, such as: x Set up an autonomous Bank Board Bureau to improve the governance of PSBs. The Bureau would search and select the banks’ heads and assist them in developing differentiated strategies and capital raising plans. x Proposal for a Micro Units Development and Refinance Agency (MUDRA) Bank through a statutory enactment. The Bank would be responsible for regulating and refinancing all micro-finance institutions which are in the business of lending to micro/small business entities engaged in manufacturing, trading and services activities. It would partner with state and regional level coordinators to provide finance to ‘last mile financer’ of small/micro business enterprises. x Set up a task force to establish a sector-neutral Financial Redressal Agency, as per the recommendation of the Financial Sector Legislative Reforms Commission, to address grievances against all financial service providers as a one-stop shop. The agency along with the other ongoing efforts on financial literacy could help in making manufacturers and distributers of financial products more accountable and investors less wary of availing financial services. x To harmonize the regulatory environment for Non-Banking Financial Corporations (NBFCs) and commercial banks, the RBI announced tighter norms for NBFCs, which included an increase in the minimum capital requirement, tighter rules on deposits and bad loans and stricter corporate governance practices. In addition, the budget 2015-16 proposed that the NBFCs with a size of INR 5 billion or more would be considered as ‘Financial Institutions’ in matters related to recovery, by allowing them to access recovery provisions of the SARFAESI Act . x PSBs have been allowed to reduce government’s share in equity to 52 percent in a phased manner. In addition, a new criterion has been promulgated for determining their eligibility for capital infusion by the government. The new criterion, announced in February 2015, takes into consideration the past performance of the banks and requires that its return on assets must exceed the average for all PSBs for the past three years, and that its return on 6 World Bank estimates indicate that US$36 billion Tier I capital would be needed over the next five years to sustain capital adequacy of PSBs. 7 ICRA “Indian Banking Sector”, February 2015, indicates that the ineligible banks would need about half the PSBs’ total requirement during FY2015-FY2019 of INR 2.6 trillion in equity and around 40 percent of the INR 1.4 trillion in Additional Tier I capital to meet their growth objectives and to comply with Basel III norms. April 2015 THE WORLD BANK 8 Towards a higher growth path India Development Update equity must be higher than the average for the past one year.8 As per this criterion, only 9 PSBs were found eligible to receive equity from the government; and would receive altogether INR 69.9 billion in the upcoming fiscal year.9 x The RBI awarded two new bank licenses; and laid the norms for small finance and payment banks. 4. Inflation Average CPI After averaging at 7.3 percent in the first half of 2014-15, inflation declined sharply inflation declined by to 4 percent in the third quarter before stabilizing at 5.2 percent, yoy, in the last 4 percentage points quarter of 2014-15. The moderation in inflation was broad based and reflected both in 2014-15– falling in the WPI and CPI series; as well as separately in core inflation and in food and from an average of 10 fuel inflation—the two components with a cumulative weight exceeding 50 percent percent in 2013-14 to in the CPI index (Figure 7). To the extent that it is reflected in a moderation of rural 6 percent in 2014-15 wages, as well as in a decline in inflationary expectations, the current decline in inflation seems well anchored. Among different components that contributed to the decline in inflation, the most prominent was the sharp decline in the food and beverages category, followed by the miscellaneous category (consisting of health, education, recreation and other services, and household goods) (Figure 8). Figure 7: Moderation in Inflation (yoy) was broad based, seen in CPI, WPI; Food, and Fuel Inflation (percent change yoy) CPI Inflation WPI Inflation CPI: Food Inflation CPI: Fuel Inflation 14 16 12 14 10 12 8 10 8 6 6 4 4 2 2 0 0 May-13 May-14 Jul-13 Nov-13 Jan-14 Jul-14 Nov-14 Sep-13 Sep-14 Jan-15 Mar-13 Mar-14 Mar-15 May-13 May-14 Mar-13 Jul-13 Nov-13 Mar-14 Jul-14 Nov-14 Mar-15 Sep-13 Jan-14 Sep-14 Jan-15 -2 -4 Source: Ministry of Statistics and Programme Implementation, India. 8 ICRA “Indian Banking Sector”, February 2015, indicates that the ineligible banks would need about half the PSBs’ total requirement during FY2015-FY2019 of INR 2.6 trillion in equity and around 40 percent of the INR 1.4 trillion in Additional Tier I capital to meet their growth objectives and to comply with Basel III norms. 9 World Bank estimates indicate that US$36 billion Tier I capital would be needed over the next five years to sustain capital adequacy of PSBs. April 2015 THE WORLD BANK 9 Towards a higher growth path India Development Update Figure 8: Decline in Food and Beverages Inflation, primarily Contributed to the decline in Inflation in 2014-15 (yoy CPI Inflation in April-January of 2013-14 and April-January 2014-15) 9.8 10 FY14 FY15 8 6.7 6 5.3 3.6 4 1.9 1.5 2 1.1 0.7 0.6 0.5 0.3 0.5 0.2 0.2 0 Headline CPI Fuel & Light Housing Clothing & Pan, Tobacco & Miscellaneous Food & Beverages Footwear Intoxicants Source: Ministry of Statistics and Programme Implementation, India. Both domestic and While the decline in inflation in India is consistent with the decline in the global factors international prices of oil, food, and other commodities, domestic policy factors contributed to (Figure 9 and Figure 10)- such as restraint on food procurement prices (the moderating inflation government mandated minimum support prices of Rabi (winter) and Kharif in the past few (summer) crops increased marginally in 2014-15); releasing public food grain stocks months in the market; restrained monetary policy; and a stable or slight appreciation in exchange rate contributed as well (Figure 11). Figure 9: Several Domestic and Global Factors Contributed to Moderating Inflation in India (percent change yoy) Minimum Support Prices Wheat Minimum Support Prices Paddy:Common Rabi/Winter Crobs Kharif Crops Paddy:Grade A Barley Jowar:Maldandi Bajra 25 Gram 60 Maize Masur/Lentil Ragi Arhar/Tur 20 Rapeseed and Mustard Moong Safflower 40 Cotton:Medium Staple Cotton:Long Staple 15 Ground Nut in Shell Sunflower Seed 10 Soyabeen:Black 20 5 0 0 2012-13 2013-14 2014-15 2012-13 2013-14 2014-15 Source: Ministry of Agriculture, India April 2015 THE WORLD BANK 10 Towards a higher growth path India Development Update Figure 10: Inflation has been simultaneously declining globally, including in major emerging economies; partly driven by the global decline in the oil and commodity prices (percent change yoy) CPI Inflation Commodity Price Index for Emerging China World India (rhs) Countries Food Petroleum 7 14 60 6 12 40 5 10 20 4 8 0 3 6 -20 2 4 -40 1 2 -60 0 0 -80 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14 Jan-15 Apr-11 Oct-11 Apr-12 Oct-12 Apr-13 Oct-13 Apr-14 Oct-14 Apr-11 Oct-11 Oct-12 Oct-13 Oct-14 Jan-11 Jul-11 Jan-12 Apr-12 Jul-12 Jan-13 Apr-13 Jul-13 Jan-14 Apr-14 Jul-14 Jan-15 Source: IFS Figure 11: Exchange rate depreciation was much lower in 2014-15, (some appreciation was seen in the past few months) further abating inflationary pressures Exchange Rate, Rupee (per US$) Percent Depreciation 70 30 25 65 20 % change y-o-y 60 15 Level 10 55 5 0 50 -5 45 -10 Apr-12 Oct-12 Apr-13 Oct-13 Oct-14 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Apr-14 Jul-14 Jan-15 Jan-12 Apr-12 Oct-12 Oct-13 Jul-12 Jan-13 Apr-13 Jul-13 Jan-14 Apr-14 Oct-14 Jul-14 Jan-15 Source: Reserve Bank of India. The outlook for The favorable outlook is based on expectations that global oil and food prices inflation remains would remain low -- international agricultural prices, which fell 3.4 percent in 2014, benign going are expected to decline by another 5 percent in 2015, while oil prices are expected to forward remain relatively low; the government broadly adhering to its fiscal stance; and the recent move to the flexible inflation framework anchoring inflationary expectations. Some upside risks to food prices may arise in the event of adverse weather or unanticipated large increases in the Minimum Support Price of food grains, and because full impact of excess rains in recent months may not have been felt. April 2015 THE WORLD BANK 11 Towards a higher growth path India Development Update Box 2: Revision in the CPI series Consumer Price Index was revised in February 2014 by Figure 12: Inflation calculated using old and revised the Central Statistical Office to change the base year series of CPI Track each other quite closely from 2010 to 2012. The exercise included some methodological changes as well—converging more CPI Old CPI New 12 closely with the international practices and classification; % change over previous year using a shorter reference period for food items and a 11 longer reference period for the items that are consumed 10 at lower frequency; and using a wider set of prices to 9 calculate PDS prices. In addition, it revised the composition of the price baskets for rural and urban 8 areas, increased the number of items in each basket, and 7 reallocated the weights reflecting changing consumption 6 patterns. Accordingly, the weight on food, and fuel and light was lowered while that on clothing, footwear, and 5 miscellaneous was increased. Unlike the revision in the 4 GDP series, where the growth rates computed by using Jan-12 Jan-13 Jan-14 Jan-15 Apr-12 Oct-12 Jul-12 Apr-13 Oct-13 Jul-13 Apr-14 Oct-14 Jul-14 the old and new series deviated significantly, the revised CPI series tracked the old series quite closely. A comparison of the old and new series, Figure 12, shows Source: Central Statistical Office, India roughly similar patterns in overall inflation as well as separately in the various components of the price basket, including food and fuel inflation. CPI Old: Food CPI New: Food CPI Old: Fuel CPI New: Fuel 16 14 % change over previous year % change over previous year 14 12 12 10 10 8 8 6 6 4 4 2 2 0 0 Jan-12 Apr-12 Oct-12 Oct-13 Oct-14 Jul-12 Jan-13 Apr-13 Jul-13 Jan-14 Apr-14 Jul-14 Jan-15 Apr-12 Oct-12 Jan-12 Jul-12 Jan-13 Apr-13 Oct-13 Apr-14 Oct-14 Jul-13 Jan-14 Jul-14 Jan-15 5. Monetary Policy Policy rates were The RBI lowered the policy repo rate twice, on January 15, 2015 and March 4, 2015, lowered in the last by 25 basis points each time, to 7.5 percent in March, 2015 (Figure 13). quarter of 2014-15 Interestingly, on each occasion, the interest rate action was announced outside the regular monetary policy cycle, and hence contained a more than the usual element of “surprise”, as perceived by the markets. The RBI attributed the latest cut in the rates to inflation falling below the 8 percent target set for January 2015; the broad expectation that inflation would stay below 6 percent until January 2016; the government managing to stay within the budgeted fiscal deficit target in the current fiscal year, and its plan to consolidate the deficit in years ahead; and the proposed improvement in the quality of expenditure in the budget for next year. While the RBI did not change its policy stance during the first three quarters of the fiscal year, it announced certain other accommodative measures. The Statutory Liquidity Ratio (SLR) was lowered thrice, on June 14, 2014, August 5, 2014 and February 3, 2015, April 2015 THE WORLD BANK 12 Towards a higher growth path India Development Update by 0.50 percent each time. The RBI communicated frequently with the markets and provided forward guidance through its published bi-monthly policy reviews and regular interactions with the media and experts. Figure 13: Monetary Policy was Accommodative in the Last Quarter of Fiscal Year, 2014-15 (percent) Repo Rate Cash Reserve Ratio Reverse Repo Rate Statutory Liquidity Ratio (rhs) Marginal Standing Facility Rate 11 7 24.5 24 10 6 23.5 9 23 22.5 8 5 22 7 21.5 4 21 6 20.5 5 3 20 May-12 May-13 May-14 Jan-12 Jan-13 Jan-14 Jan-15 Mar-12 Jul-12 Nov-12 Mar-13 Jul-13 Nov-13 Mar-14 Jul-14 Nov-14 Mar-15 Sep-12 Sep-13 Sep-14 Nov-11 Dec-13 May-14 Jan-11 Jun-11 Sep-12 Oct-14 Mar-15 Apr-12 Feb-13 Jul-13 Source: Reserve Bank of India The government and As per the new framework, signed on February 20, 2015, based on the the RBI signed the recommendation of the Urjit Patel Committee Report (submitted in January 2014), flexible inflation it was agreed that the RBI would adhere to a “flexible inflation target”, and to a targeting framework Target of CPI inflation below 6.0 percent by January 2016 and a Target of 4 for monetary policy percent, within a band of (+/-) 2 percent around it, by end-2016-17. The objective which is likely to of monetary policy would be to “primarily maintain price stability while keeping in enhance the mind the objective of growth”. The RBI would be required to bring out a document credibility of every six months explaining the sources of inflation and providing inflation forecast monetary policy for the following 6-18 months. If inflation exceeds more than 6 percent for three straight quarters in 2015-16, or falls below 2 percent for three straight quarters in 2016-17, the RBI would have to explain the reasons for not meeting the target and lay out the remedial actions.10 One challenge that As has been acknowledged by the RBI on numerous occasions, monetary policy the RBI continues to actions do not seem to filter down adequately, or fast enough, to the interest rates face is the weak on bank deposits and bank credit. The RBI Governor has also talked about an transmission of asymmetry in the behavior of banks -- while they have been relatively more monetary policy responsive in raising the interest rates after policy tightening, they lower rates more slowly or inadequately in response to an easing. This problem is not unique to India though. In developing countries in general, the transmission mechanism is considered weak due to factors such as the prevalence of economic activities in the informal sector, and in particular due to informal financing. Additionally, in India PSBs are believed to propagate the monetary policy less efficiently than private banks.11 The transmission mechanism could get strengthened in the period ahead 10 According to the Inflation Expectations Survey of Households: December 2014, published by the Reserve Bank of India, fewer households expect higher inflation during the next three months, than in the past. 11 As shown in Gupta, Kochhar and Panth (2015), Bank Ownership and the Effects of Financial Liberalization: Evidence from India, forthcoming Indian Growth and Development Review. April 2015 THE WORLD BANK 13 Towards a higher growth path India Development Update with the current drive on financial inclusion that has been able to bring a previously unbanked population within the ambit of the formal financial sector as well as when the PSBs gain more operational autonomy, are more professionally managed, or when ownership issues are addressed, as is being currently proposed by the government. 6. Fiscal Developments and Union Budget The fiscal deficit Fiscal deficit target of 4.1 Figure 14: Revised Estimates for Tax Revenue in 2014- target of 4.1 percent percent of GDP will be 15 are lower than Budgeted, necessitating Expenditure of GDP in 2014-15 is achieved even as revenue Compression to meet the Fiscal Deficit Target expected to be met collection remained weak, 2014-15 (BE) 2014-15 (RE) despite weak by compressing both 16 revenue outcomes, current and capital 12.2 11.8 10.6 9.9 primarily through expenditure. Capital 12 % of GDP expenditure expenditure, budgeted at a 8 compression low 1.8 percent of GDP, 4 1.6 1.7 1.8 1.5 achieved an even lower realization of 1.5 percent 0 of GDP in the revised Gross Tax Revenue Expenditure Capital Expenditure Non Tax Revenue Revenue estimates; while the current (revenue) expenditure at 11.8 percent of GDP was also lower than the budgeted 12.2 percent of GDP Source: Ministry of Finance, India (Figure 14). Revenue collection While almost all tax collection targets slipped, the lower outturn was predominantly was weak in 2014-15 due to the slippage in Service Tax collection that underperformed at 1.3 percent of as indirect tax GDP, 0.4 percent of GDP lower than the budgeted 1.7 percent. Since 2000-01, the collection, share of Service Tax in total indirect taxes and as a share of GDP has been on a particularly service steady rise. The government, in an attempt to widen the tax base and improve tax, and compliance introduced a concept of a Negative List of Services (list of services disinvestment exempt from Service Tax) since July, 2012, a list that can only be amended following receipts were lower parliamentary approval. The outturn of Service Tax in 2013-14 was higher than the than budgeted norm, which could have been driven by a one-time government scheme that allowed defaulters to pay their unpaid service taxes in the last 5 years without incurring any additional interest, penalty or legal proceedings, by December, 2013, supported by a strong public awareness campaign to pay all Service Tax dues. Disinvestment receipts were lower at 0.2 percent of GDP than the budgeted 0.5 percent of GDP, because the planned disinvestment in CPSEs and the government stake in non-government companies did not materialize. Subsidy bill was The total subsidy expenditure at 2.1 percent of GDP during fiscal year 2014-15 was higher than marginally higher than the budgeted 2.0 percent of GDP (Figure 15). Declining budgeted in 2014-15 global crude prices and a phased increase in retail diesel prices allowed for a because of higher complete deregulation of diesel prices in October, 2014, resulted in a significant food subsidies reduction in petroleum subsidies from the 2013-14 outturn of 0.8 percent of GDP to 0.5 percent in 2014-15. Food subsidy expenditure during the same period April 2015 THE WORLD BANK 14 Towards a higher growth path India Development Update increased from 0.8 percent of GDP to 1.1 percent of GDP, offsetting the decline in petroleum subsidies12. Figure 15: While Revenue outturns are expected to be lower than budgeted in 2014-15, Subsidies overshot marginally (percent of GDP) 6 5.7 3.0 2013-14 2.6 2013-14 4.8 5 2.5 2014-15 (BE) 2014-15 (BE) 2.0 2.1 4 3.5 2.0 2014-15 (RE) 2014-15 (RE) 3 5.6 5.5 1.5 2.2 1.1 2 1.7 1.6 1.6 4.4 4.3 1.0 0.8 0.8 0.9 3.5 3.4 0.6 0.6 0.6 0.5 0.5 1 0.5 2.1 2.2 0.5 1.4 1.3 1.5 1.5 1.5 1.5 0.3 0.2 0 0.0 Privatization Taxes on Indirect Taxes Direct Taxes Service Tax Customs Corporate Excise Tax Subsidy Fertilizer Subsidies Petroleum Subsidy Income Duties Subsidy Food Tax Source: Ministry of Finance, India Budget for 2015-16 The government proposed Figure 16: Fiscal Deficit Outturns and the Glide Path of envisages a modest to slow the pace of fiscal Deficit in the Years Ahead fiscal consolidation, consolidation, and Gross Fiscal Deficit, % of GDP with deficit at 3.9 consolidate deficit to 3 8 6.8 6.5 percent of GDP percent of GDP in next 6.0 6.0 three years, instead of two 6 5.2 4.7 % of GDP 4.3 as was proposed in the 3.9 3.5 4 previous budget. The glide 3 path of deficit is set to be 2 at 3.9 percent, 3.5 percent and 3.0 percent respectively 0 in 2015-16, 2016-17 and 2014-15 (RE) 2008-09 2009-10 2010-11 2011-12 2012-13 2013-14 2015-16 (BE) 2016-17 (BE) 2017-18 (BE) 2017-18. The new glide path was chosen to open up fiscal space for ‘funding infrastructure investment”.13 Source: Ministry of Finance, India The budget proposes Following the recommendations of the Fourteenth Finance Commission, share of to devolve a larger the States in divisible taxes is budgeted to increase from 32 percent to 42 percent of share of tax revenue the gross tax revenue in nominal terms – an increase from 2.7 percent of GDP in to the states; and to revised estimate for 2014-15 to 3.7 percent of GDP in 2015-16 (see Box 3). compress revenue Consequently, the net tax revenue retained by the Central government would 12 Petroleum subsidies amounting to INR 450 billion were rolled over from 2012-13 to 2013-14. After absorbing INR100 million in 2013-14, the balance INR 350 billion (0.3 percent of GDP) was further rolled over to 2014-15. This practice of rolling over has no precedence prior to 2012-13 and has not been carried out in 2015-16 budget. If the rolled over amount is taken into account, the reduction in oil subsidy burden in 2014-15 effectively works out to be even sharper, from 1.1 percent in 2013-14 to 0.5 percent of GDP in 2014-15. 13 Budget speech, Union Budget 2015-16. April 2015 THE WORLD BANK 15 Towards a higher growth path India Development Update expenditure. decline to 6.5 percent of GDP. The current expenditure compression is projected in view of the lower retained tax, even as capital spending is restored to the level seen in 2013-14, at 1.7 percent of GDP. Reduction in fuel subsidy is expected to contribute to the savings on current expenditure. While the budget allocates a larger share of the tax revenue to the States, it also proposes to lower the share of the Center in the Centrally Sponsored Schemes, thus granting more discretion to the States in spending the larger tax receipts. Our calculations show that the net transfer of resources to the states, taking into account lower devolution of other grants and loans turns out to be of the order of 0.5 percent of GDP.14 Figure 17: Center to devolve a Larger Share to the States; Lower Current Expenditure, including Fuel Subsidies, while restoring Capital Expenditure 2013-14 2014-15 (RE) 2015-16 (BE) 2013-14 2014-15 (RE) 2015-16 (BE) 16 3 12 % of GDP 2 % of GDP 8 4 1 0 Net Tax Revenue Gross Tax Revenue Capital Expenditure Revenue Expenditure 0 Non Tax Revenue Food Subsidy Fertilizer Subsidy Petroleum Subsidy Subsidies Source: Ministry of Finance, India Table 3: Central Assistance to State Plans has been restructured to partially compensate for the increased tax devolution to the States (In billions of INR, percent of GDP) 2014-15 (RE) 2015-16 (BE) 2014-15 (RE) 2015-16 (BE) Tax devolution 3378.08 5239.58 2.7 3.7 Total Grants and Loans 3551.93 3282.77 2.8 2.3 Central Assistance to State 2702.69 1957.78 2.1 1.4 Plans Non Plan Grants and Loans 803.38 1086.30 0.6 0.8 Centre/centrally sponsored 45.86 238.69 0.0 0.2 schemes Total Transfer to States and UTs 6930.01 8522.35 5.5 6.0 Source: Union Budget 2015-16 Meeting fiscal The gross tax revenue in 2015-16 is expected to increase to 10.3 percent of GDP, targets is conditional from 9.9 percent of GDP in 2014-15 (RE), and 10 percent of GDP in 2013-14 on realization of tax (Figure 18). Some extra tax buoyancy is built in these estimates compared to the last buoyancy, and year. At a disaggregated level, tax buoyancy is particularly assumed in the collection disinvestment of indirect taxes. receipts 14 The preliminary estimates calculated by Dr. Rathin Roy of NIPFP (Business Standard, March 1, 2015) show that the center’s contributions to flagship schemes, and central assistance for state plans has declined; and the net transfer of resources to the states would be of the order of 0.3 percent of GDP. April 2015 THE WORLD BANK 16 Towards a higher growth path India Development Update Figure 18: Revenue Projections for 2015-16 seem optimistic compared to the past Two Years 2013-14 2014-15 (RE) 2015-16 (BE) 6 5.6 5.5 5.6 4.6 5 4.4 4.3 4 3.5 3.4 3.3 % of GDP 2.3 3 2.1 2.2 1.5 1.6 1.5 2 1.4 1.3 1.5 1.5 1.5 1.5 0.5 1 0.3 0.2 0 Corporate Tax Indirect Taxes Privatization Customs Duties Service Tax Taxes on Income Excise Tax Direct Taxes Source: Ministry of Finance, India In the past, Budgeted disinvestment receipts (at 0.5 percent of GDP) in 2015-16 may turn out government has to be optimistic. Even though thrice in the past the privatization receipts have been often under realized about 0.5 percent of GDP (in FY1992, FY1995, and FY2004), the average in other the proceeds from years has been lower—the average annual receipts during 2010-2014 were 0.2 disinvestment percent of GDP (Figure 19).15 Whether the actual fiscal outcomes would be close to the budgeted would depend crucially on oil prices staying low and the government’s ability to keep subsides under check, while maintaining the elevated excise rates on petroleum products (see Special Issues I, below). Figure 19: Disinvestment Receipts have often been less than Budgeted in the Past Budgeted receipt Total receipts 0.6 0.5 0.4 % of GDP 0.3 0.2 0.1 0.0 2014-15… 2015-16… 1991-92 1992-93 1993-94 1994-95 1995-96 1996-97 1997-98 1998-99 1999-00 2000-01 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 2010-11 2011-12 2012-13 2013-14 Source: Ministry of Finance, India 15 Planned disinvestment budgeted in 2015-16 would be channelized into a National Investment Fund (NIF) to be used to recapitalize Public Sector Banks and for capital expenditures for the Indian Railways. April 2015 THE WORLD BANK 17 Towards a higher growth path India Development Update Box 3: Recommendation of the Fourteenth Finance Commission The Finance Commission, constituted every five years by the President of India, makes recommendations on the sharing of tax proceeds between the Center and the State governments from the divisible pool of taxes, i.e. the central taxes excluding surcharges and cesses (the vertical devolution of taxes); as well as on the distribution of tax proceeds across states (called the horizontal devolution). It also reviews the finances of the Center and the States and makes broad recommendations on their fiscal stance and the pace of fiscal correction. The Fourteenth Finance Commission, in a report submitted recently to the President and subsequently tabled in the Budget Session of the parliament, recommended a larger share of the Central tax revenue to be shared with the States than in the past. It recommended that the States’ share in net proceeds of the Central tax revenues increase to 42 percent from the 32 percent recommended by the Thirteenth Finance Commission, and similar shares recommended by the previous commissions. It further recommended tax devolution to be the primary source of transfer of resources to the States, reinforcing the ongoing emphasis on greater decentralization. These recommendations mark a significant departure from the recent trend, wherein the share of Plan grants to the States, relative to the statutory grants, has increased in the past few years; along with the number of Centrally Sponsored Schemes and ‘tied’ assistance to the States, many of them requiring matching contributions from the states. The trend is believed to have reduced the fiscal space and spending discretion available to the Sates. The recommendations of the Finance Commission derive from two considerations. First, the States’ developmental priorities and challenges differ vastly from each other; and second, the States have become fiscally more prudent. They have enacted their own fiscal rules, and broadly adhered to those, and are expected to expend the additional resources in a fiscally prudent manner and as per their own developmental imperatives. Some of the other recommendations of the Finance Commission are the following. Horizontal Devolution: On the allocation of tax revenue across states, keeping up with the past recommendations, the Fourteenth Finance Commission allocated a large weight of 50 percent, to the income level, specifically, the distance from the highest per capita income district (as a measure of fiscal capacity); followed by a weight of 27.5 percent to population (17.5 percent to the level of population in the 1971 census, and a 10 percent weight to population in the 2011 census, thereby accounting for demographic changes); a 15 percent weight to area; and a remaining 7.5 percent weight to the forest cover of the states. In assigning these weights, unlike the past commissions, the Fourteenth Finance Commission did not give any weight to the fiscal outcomes of the states. The reassigning of weights across categories, and the changing economic and demographic status of the states, imply that their share in the Center’s divisible taxes has changed since the Thirteenth Finance Commission, as depicted in Figure 20 below. Table 4: Recommended Criteria for Horizontal Devolution of Tax Revenue among States 11th FC 12th FC 13th FC 14th FC Income Distance 62.5 50 47.5 50 Population/ 10 25 25 17.5 Demographic 10 Area 7.5 10 10 15 Fiscal performance/ Tax effort/ Fiscal discipline 7.5 7.5 17.5 Infrastructure 7.5 Forest Cover 7.5 Source: Reports of the respective Finance Commissions April 2015 THE WORLD BANK 18 Towards a higher growth path India Development Update Figure 20: Change in the Distribution of Tax Revenue across States in the Fourteenth Finance Commission, over the Thirteenth Finance Commission 1.5 Change in the Statewise Share of Revenues 1 (Difference of 14th FC and 13th FC, percentage points) 0.5 0 -0.5 -1 -1.5 -2 Andhra Pradesh… Jammu&Kashmir Bihar Uttar Pradesh Tamil Nadu Haryana Goa Nagaland Punjab Mizoram Jharkhand Karnataka Chhattisgarh West Bengal Manipur Maharashtra Madhya Pradesh Rajasthan Odisha Gujarat Sikkim Tripura Kerala Meghalaya Arunachal Pradesh Assam Uttarakhand Himachal Pradesh States Source: Economic Survey, India Fiscal Institutions and Consolidation: The Finance Commission also made recommendations on the medium term fiscal outcomes of the Center and the States, as well as on budgetary institutions. These include: x Fiscal deficit of the Center should be lowered to 3.6 per cent of GDP in 2015-16, from projected 4.1 per cent in 2014-15; to 3 per cent in the following year; and kept at 3 percent for three more years. It recommended a similar time path of the Center’s revenue deficit--to be brought down to 2.9 per cent in 2014-15, 2.56 per cent in 2015-16, and progressively reduced to 0.93 per cent by 2019-20. It recommended that the subsidy bill should be gradually lowered from 1.6 percent of GDP in 2016-17 to 1.0 percent of GDP in 2019-20, by reducing it by 0.20 percent of GDP each year in between. It recommended that the debt stock of the Union Government should decline from 43.6 percent of GDP in 2015-16 to 36.3 percent of GDP in 2019-20; and the fiscal deficit of the States to be anchored to an annual limit of 3 per cent of the Gross State Domestic Product. x Further, its recommendations included that the Fiscal Responsibility and Budgetary Management (FRBM) Act should be replaced with a Debt Ceiling Fiscal Responsibility Legislation. On the long-term fiscal reform agenda, it favored a rule-based approach for the Center and the States; and that the government should establish an independent fiscal council to undertake ex-ante assessment of the implications of budget proposals and their consistency with the established fiscal policy and rules. It also recommended that the Union Government should consider setting up a Consolidated Sinking Fund to create a cushion to meet repayment obligations in times of fiscal stress and facilitate borrowings in the primary market at reasonable costs. Goods and Services Tax (GST): The Fourteenth Finance Commission proposed a somewhat more generous compensation formula for the States than is currently being considered—it recommended compensation to the States for five years, instead of three--with 100 percent compensation to be paid in the first three years followed by a compensation of 75 percent in the fourth year and 50 percent in the final year. It recommended the creation of an autonomous and independent GST Compensation Fund through legislative action, thus generating a guaranteed pool of funds to compensate the States for their temporary loss of revenue. 7. Balance of Payments The balance of Sharp decline in oil prices since June 2014, helped contain the trade deficit to $112 payment outlook billion (7.4 percent of GDP) in the first three quarters of 2014-15, lower than the improved during the $117 billion (8.4 percent of GDP) over the same period in the previous fiscal year year, with a decline (Figure 21). Along with the steady stream of remittances and receipts from service in the current exports, lower trade deficit helped in curtailing the current account deficit to $26 April 2015 THE WORLD BANK 19 Towards a higher growth path India Development Update account deficit and a billion (1.7 percent of GDP) in the first three quarters of the fiscal year, compared pickup in capital to $31 billion (2.2 percent of GDP) in the three quarters of 2013-14 – a significant flows improvement over the previous two years when the current account deficit averaged $83 billion in respective three quarters. Simultaneously, buoyancy in capital inflows, particularly from portfolio investors, was reflected in some exchange rate appreciation and led the RBI to accumulate foreign exchange reserves which increased to $338 billion as of February 27, 2015. Figure 21: Decline in the Value of Oil Import helped restrain Trade Deficit and the Current Account Deficit Curren Account Deficit Gold Merchandise Trade Deficit Import Oil Non-Gold Non-Oil 80 -60 60 -40 Bil.US$ Bil.US$ 40 -20 0 20 20 0 Q1 2004-05 Q4 2004-05 Q3 2005-06 Q2 2006-07 Q1 2007-08 Q4 2007-08 Q3 2008-09 Q2 2009-10 Q1 2010-11 Q4 2010-11 Q3 2011-12 Q2 2012-13 Q1 2013-14 Q4 2013-14 Q3 2014-15 Q1 2004-05 Q4 2004-05 Q3 2005-06 Q2 2006-07 Q1 2007-08 Q4 2007-08 Q3 2008-09 Q2 2009-10 Q1 2010-11 Q4 2010-11 Q3 2011-12 Q2 2012-13 Q1 2013-14 Q4 2013-14 Q3 2014-15 Source: Reserve Bank of India The sharp decline in Crude petroleum imports, accounting for more than 30 percent of all merchandise the price of oil imports in India, meet more than three-fourths of the country’s demand for oil. helped reduce India is also a large exporter of refined petroleum–accounting for nearly 20 percent merchandise trade of total merchandise exports. During 2012-2014 net imports of petroleum average deficit, while gold nearly $100 billion a year. As global crude prices declined from June 2014, India’s oil imports were import bill also declined. Value of crude oil imports declined by 8 percent yoy contained during Apr 2014-Jan 2015, and tempered the impact of the increase in the demand for other imported goods – such as consumer durables, capital goods or industrial raw materials, on the current account. India has traditionally also been a large importer of gold. The import of gold averaged about $12 billion a year in 2005- 2008, but escalated to nearly $55 billion a year during 2012 and 2013. Due to the import restrictions and the decline in its price globally, gold import fell by 47 percent in 2013-2014. It revived subsequently, increasing by 10 percent yoy during April-December 2014, but remained below the levels seen in earlier years, see Box 4. Services exports and Merchandise exports registered tepid growth during the first three quarters of 2014- remittances 15, primarily because of the decline in the exports of petroleum and gems and increased at a steady jewelry. The decline in global oil prices had an adverse impact on the value of pace countering the exported refined petroleum products from India, which declined by 2 percent yoy impact of stagnant during Apr 2014-Jan2015. Exports were subdued despite a 10 percent increase in merchandise exports exports to the U.S., India’s largest export destination, as exports declined to other on the current account countries including China and Singapore. Remittances and services exports earnings continued to increase steadily as in the past years, and their outlook is considered robust (see Figure 22 and Box 5). April 2015 THE WORLD BANK 20 Towards a higher growth path India Development Update Figure 22: Services Exports and Remittances Increased at a Steady Pace; while Merchandise Exports Stagnated Remittances Net Services Balance Export of Goods 25 Non Oil & Non Gems Jewellery Export 100 20 80 Bil US $ 15 Bil.US$ 60 10 40 5 20 0 0 Q3 2006-07 Q1 2007-08 Q3 2007-08 Q1 2008-09 Q3 2008-09 Q1 2009-10 Q3 2009-10 Q1 2010-11 Q3 2010-11 Q1 2011-12 Q3 2011-12 Q1 2012-13 Q3 2012-13 Q1 2013-14 Q3 2013-14 Q1 2014-15 Q3 2014-15 Q1 2004-05 Q4 2004-05 Q3 2005-06 Q2 2006-07 Q1 2007-08 Q4 2007-08 Q3 2008-09 Q2 2009-10 Q1 2010-11 Q4 2010-11 Q3 2011-12 Q2 2012-13 Q1 2013-14 Q4 2013-14 Q3 2014-15 Source: Reserve Bank of India and Ministry of Commerce, India FDI inflow and Capital flows remained robust, foreign investment inflows (direct and portfolio) Portfolio flows regained strength and reflected in an increase to 3.4 percent of GDP during Q1-Q3 helped finance the 2014-15 from 1.4 percent during 2013-14. As has been observed widely, FDI flows current account continued to be more stable than the portfolio flows, which along with bank flows deficit and exhibited volatility (Figure 23). The balance of flows shifted towards more volatile contributed to portfolio capital flows, which totaled about $28 billon in the first three quarters of reserve accretion the fiscal year, compared to FDI flows at nearly $24 billion.16 Figure 23: FDI inflows, and Portfolio inflows were Robust in 2014-15; but over the longer term while FDI Flows were relatively Stable, Portfolio Flows and Bank Flows Exhibited Volatility Portfolio Investment Banking Capital FDI 18 20 16 15 14 12 10 Bil.US$ Bil.US$ 10 5 8 6 0 4 -5 2 0 -10 Q1 2004-05 Q4 2004-05 Q3 2005-06 Q2 2006-07 Q1 2007-08 Q4 2007-08 Q3 2008-09 Q2 2009-10 Q1 2010-11 Q4 2010-11 Q3 2011-12 Q2 2012-13 Q1 2013-14 Q4 2013-14 Q3 2014-15 Q1 2004-05 Q4 2004-05 Q3 2005-06 Q2 2006-07 Q1 2007-08 Q4 2007-08 Q3 2008-09 Q2 2009-10 Q1 2010-11 Q4 2010-11 Q3 2011-12 Q2 2012-13 Q1 2013-14 Q4 2013-14 Q3 2014-15 Source: Reserve Bank of India 16 The government eliminated the regulatory distinction between different categories of foreign investment such as Foreign Portfolio Investors and Foreign Direct Investment; and proposed to amend the Finance Bill, Section-6 of FEMA to provide that the equity flows of both FDI and portfolio would be regulated by the Government, in consultation with the RBI. April 2015 THE WORLD BANK 21 Towards a higher growth path India Development Update After the sharp The relative stability of the nominal exchange rate, given India’s inflation rate, depreciation in the translated in an appreciation of the real exchange rate (Figure 24). Competitive exchange rate in exchange rates are widely considered vital for exports growth, and the RBI’s policy 2013, exchange rate towards the exchange rate has been a subject of much debate (see e.g. Economic appreciated in early Survey). Portfolio capital flows in particular were correlated with the nominal 2014, and has been appreciation of the rupee, necessitating vigilance and some intervention in the stable in the past few foreign exchange market by the RBI, as reflected in the accumulation of reserves in months 2015. Figure 24: While Nominal Exchange Rate was broadly stable, the Real Exchange Rate Appreciated REER Portfolio Investment 12000 Exchange Rate(INR/US$) 30 140 36 Currency: Trade Weighted 6 Currency: Trade Weighted 25 8000 130 20 % Change y-o-y 4000 120 15 Mil.US$ 0 10 110 5 -4000 100 0 -8000 90 -5 -12000 -10 80 May-11 May-12 May-13 May-14 Jan-11 Sep-11 Jan-12 Sep-12 Jan-13 Sep-13 Jan-14 Sep-14 Jan-15 Jun-04 Jun-06 Jun-08 Jun-10 Oct-03 Jun-12 Feb-05 Oct-05 Jun-14 Feb-07 Oct-07 Feb-09 Oct-09 Feb-11 Oct-11 Feb-13 Oct-13 Source: Reserve Bank of India Reserve Bank of Benign inflationary conditions continue to prevail globally, aided by the decline in India built oil prices, allowing for accommodative monetary policies in developed economies. international buffers Even as the Federal Reserve Board has maintained its current stance on monetary as a “first line of policy for the time being, the expectations are rife that it would start tightening its defense”, and took monetary policy sometime in 2015, and possibly as early as in summer this year. In additional measures the event that a tightening of the US monetary policy disrupts capital flows to to reduce external emerging markets, India being one of the large financial markets, and a large vulnerability17 recipient of capital flows, could be adversely affected by this rebalancing. Just like the other emerging markets, India has also rebuilt its reserve buffer after the tapering talk episode, increasing it to $338 billion as of February 27, 2015, enhancing its coverage to meet sharp increases in the demand for foreign currency or the shocks to global liquidity.18 However a larger The RBI officials have pointed out that a larger reserve cover should not be reserve cover should construed as a substitute for other important mitigation measures, such as hedging not be construed as a against currency exposures; or specific capital flow measures to avoid building short substitute for other term external liabilities (especially portfolio debt flows). Recognizing the importance important mitigation of these additional measures, the RBI has encouraged the corporate sector to hedge measures its exchange rate exposures, and has cautioned the banks to take a prudent view in lending to the corporates with unhedged positions. It sought to lengthen the maturity profile of the government and corporate debt held by foreign investors (to at least three years of minimum residual maturity) as an additional prudent measure. 17 Asindicated in a speech by Deputy Governor Mr. Harun Khan, February 24, 2015. The level of reserves that India has held in recent years is considered adequate on most adequacy 18 metrics (including in the IMF’s recent assessment of the Indian economy). April 2015 THE WORLD BANK 22 Towards a higher growth path India Development Update Figure 25: International Reserves Increased Providing a Buffer against External Vulnerability Stock of Foreign Exchange Reserves 25 Quarterly Foreign Exchange Reserve 360 Accumulation 20 340 15 320 10 Bil.US$ 5 Bil.US$ 300 0 280 -5 260 -10 -15 240 Q1 2009-10 Q3 2009-10 Q1 2010-11 Q3 2010-11 Q1 2011-12 Q3 2011-12 Q1 2012-13 Q3 2012-13 Q1 2013-14 Q3 2013-14 Q1 2014-15 Q3 2014-15 220 May-09 May-10 May-11 May-12 May-13 May-14 Jan-09 Sep-09 Jan-10 Sep-10 Jan-11 Sep-11 Jan-12 Sep-12 Jan-13 Sep-13 Jan-14 Sep-14 Jan-15 Source: Reserve Bank of India Box 4: Recent development in gold imports India traditionally imports a large amount of gold, about 850 tons a year, contributing nearly a quarter of the global demand. The demand for gold increased by about 20 percent starting in 2010, when it averaged 970 tons a year between 2010-2013, after averaging 750 tons in 2005-2008. Combined with high gold prices, it reflected in the import of gold escalating to nearly $55 billion in 2012-12 and 2012-13, compared to an average annual import of about $12 billion in 2005-2008. At these peak levels, gold comprised 10 percent of the entire import basket. The period in which gold imports increased coincided with high domestic inflation; as well as a rapid rise in the price of gold globally (Figure 26)--suggesting that the surge in the import of gold could be attributed to inflation hedging by Indian importers; when gold simply seemed a better store of value with its price increasing robustly. Figure 26: Gold Imports Correlate Positively with Domestic Inflation and With the International Price of Gold 60 Gold Imports 1800 60 Gold Imports 14 1600 CPI Inflation 12 50 Gold Price 50 1400 US$/Troy Ounce 10 40 1200 40 Bil.US$ 1000 Bil.US$ 8 30 30 % 800 6 20 20 600 4 400 10 10 2 200 0 0 0 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2000 2002 2004 2006 2008 2010 2012 2014 Source: Reserve Bank of India, and IMF April 2015 THE WORLD BANK 23 Towards a higher growth path India Development Update Rising gold imports being partly responsible for Figure 27: Along with the Import of Gold, Exports the increase in current account deficit, the of Gems and Jewelry have Moderated Recently government announced several measures in 2013, Gold Imports both tariff and quantitative restrictions, to restrain Gems and Jewellery Export their imports, see Table 5. It raised the import 60000 duty on gold to 6 percent in January 2013 (from 4 percent earlier), to 8 percent on June 5, 2013, 10 50000 percent on August 13, 2013; and further the duty 40000 on the import of gold jewelry was raised to 15 Mil.US$ percent on September 18, 2013. These were 30000 accompanied by restrictions, such as prohibiting 20000 the import of gold coins, and a 20/80 rule requiring that 20 percent of the gold imports 10000 would be made available to exporters while only 0 the rest 80 percent could be used domestically. 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 These measures helped curtail the import of gold; the import volume declined to 670 tons in 2013- 14, while in value, imports declined by nearly $25 Source: Reserve Bank of India billion. These apparently successful measures also raised some concerns. The main concern being that the import restrictions might have affected the exports of gold jewelry, by increasing the price of gold bullion, Figure 27; another concern is that the large difference between the domestic and international price of gold might have generated incentives for circumventing these measures by importing gold without declaring it to the customs.19 The government and the RBI has lifted several of these restrictions recently, while the import duty has prevailed. Table 5: Import Restrictive Measures on the Import of Gold Date Gold Import Measures Jan-13 Import duty on gold raised to 6 percent from 4 percent May-13 RBI allowed banks to import gold only on a consignment basis, bans Banks and NBFCs from lending against gold ETFs and MFs Jun-13 Letters of credit opened by banks or gold import agencies to be on 100 percent margin basis Jun-13 Gold import duty increased to 8 percent from 6 percent Jul-13 Introduction of 20:80 scheme, i.e. 20 percent of every lot of gold imports to be used for exports Jul-13 Restricted Star/premium trading houses to import gold "exclusively" for exports Aug-13 Import duty on gold and Silver raised to 10 percent from 8 percent earlier Sep-13 Import duty on gold jewelry increased to 15 percent May-14 Trading houses (star/premium) allowed to import gold under 20:80 scheme May-14 Banks allowed to provide gold metal loans to domestic jewelry manufacturers Nov-14 Withdrawal of 20:80 scheme, and other restrictions introduced since August, 2013 Feb-15 RBI lifted the ban on import of gold coins and medallions by banks and trading houses Source: Reserve Bank of India 19 The World Gold Council has estimated that due to these measures, nearly 200 tons of gold has been smuggled into India (see Reuters, July 10, 2014). Some recent news reports have confirmed such reports. http://www.euronews.com/newswires/2956910-india-seizes-record-haul-of-smuggled-gold- outside-airport/ April 2015 THE WORLD BANK 24 Towards a higher growth path India Development Update 8. Global Developments20 Global growth While the sharply lower Figure 28: Global Growth Remains Soft remains soft despite oil price is reflected in a World GDP growth - qoq saar lower oil prices significant pick-up in 4 retail sales and falling World GDP growth - yoy inflation across major oil importing economies, 3 global growth remains soft (Figure 28), 2 reflecting divergent % trends between oil 1 importers and oil exporters and persistent 0 headwinds in a number 2013Q1 2013Q2 2013Q3 2013Q4 2014Q1 2014Q2 2014Q3 2014Q4 of large economies. Growth in the fourth quarter of 2014, Source: World Bank, Haver Analytics annualized quarter-on- quarter, is estimated at 2.7 percent, down from 3.5 percent in the third quarter; a similar or slightly softer momentum is expected in the first quarter of 2015. Growth lacks The modest global growth outlook is further marred by divergent outlooks across momentum among countries and regions. In particular some of the economies bearing significant trade India’s major trading and financial links with India have registered slow growth. Countries that figure partners and origin most prominently among India’s export destinations include the UAE, Saudi of FDI Arabia, the broader set of GCC; as well as China, US and Europe. In inflows of foreign direct investment, the countries that dominate (after Mauritius and Singapore) include the US, UK, Japan and the larger countries in the Euro Zone. Growth outcomes in these countries remained subdued in Q4, 2014 (Figure 29). Following an exceptionally strong third quarter, growth in the United States decelerated to 2.6 percent in the fourth quarter of 2014. The deceleration was accompanied by a marked shift in the composition of growth—while consumption picked up strongly, consistent with declining oil prices and strong labor market conditions; export growth slowed down, perhaps due to a stronger US dollar. In Japan, technically recession ended in the fourth quarter, with growth bouncing back to 2.2 percent; but the annualized, quarter-on-quarter increase was modest at 0.6 percent. Growth picked up in the Euro Area, but remains modest at 1.4 percent in the last quarter of 2014; with Germany posting a much stronger performance than initially predicted. 20 The discussion draws on the World Bank (DECPG)’s monthly brief, February, 2015. April 2015 THE WORLD BANK 25 Towards a higher growth path India Development Update Figure 29: Growth remains subdued in India’s Major Trading Partners, as well in its Peers Germany UK US Japan (rhs) Brazil Russia South Africa China (rhs) 4 3 5 8.0 3 2 7.8 2 1 3 % y-o-y 7.6 % y-o-y 1 0 7.4 1 0 -1 7.2 -1 -2 -1 7.0 2013Q1 2013Q2 2013Q3 2013Q4 2014Q1 2014Q2 2014Q3 2014Q4 2013Q1 2013Q2 2013Q3 2013Q4 2014Q1 2014Q2 2014Q3 2014Q4 Source: World Bank, Haver Analytics. Contagion risks from Since elected in end January, Greece’s new government pushed for a renegotiation Greece are small for of its bailout program, which expired on February 28, but was extended by four India months. This gave reprieve to the immediate concerns about a default and eventual exit of Greece from the Euro Area and restored the supply of deposits in the Greek banks. Hence the contagion risks are limited; and are further reduced with the large scale purchases of sovereign bonds that the ECB started in March. Sovereign bond yields in countries such as Portugal, Italy, Spain or Ireland barely changed in recent weeks and remained close to historical lows. India is at low risk of first order contagion from the evolving situation in Greece, with hardly any trade, financial or remittances links. Oil importing Growth decelerated to 6.8 percent in the fourth quarter (annualized quarter-on- emerging economies quarter) in China, with declining contributions from net exports and housing benefited from the investment. China's January trade data was markedly weak, with both exports (-3.3 decline in oil prices, percent yoy) and imports (-19.9 percent yoy) declining. Even so, China’s current but it did not prove account remains in surplus. Its net capital flows turned into deficit in the last quarter sufficient to make of 2014, while capital outflows were manageable, they pose additional policy their economic challenges for Chinese authorities. In Indonesia, growth momentum remained outlooks brighter relatively soft as the positive impact of a sharp drop in oil prices was partly offset by declining prices of coal and crude palm oil impacting export revenues. Despite lower oil prices, inflation in Brazil has been ticking upwards amidst weakening retail sale; justifying the central bank’s continued hikes in interest rates. Industrial production contracted further in the final quarter of 2014, dimming prospects of significant recovery in the short-term. Headwinds are Slowdown in the Middle East may adversely impact the demand for Indian exports expected to intensify as well as remittances flows originating in the regions (though the effect may not be in oil exporting quantitatively significant, see Box 5). Among other larger oil exporting emerging economies, with countries, Russia has been severely affected by declining oil prices, compounding some possible the impact of international sanctions that it faces. While its foreign reserves implications for continued to decline in January and February this year; its GDP is predicted to India contract significantly in the first quarter of 2015. Nigeria has also shown signs of increasing vulnerability, with low foreign exchange reserves, a deteriorating fiscal position and increasing political uncertainty. Sentiment and activity have been slightly weaker than expected in Mexico. Individually, however, the growth April 2015 THE WORLD BANK 26 Towards a higher growth path India Development Update outcomes in these countries are unlikely to be of much consequence to impact trade, or financial flows to India. Oil prices are Crude oil prices increased during February after hitting a 6-year low in late January, expected to remain due to downward adjustment in the US oil supply capacity, even as OPEC low, and aide in continues to maintain supply levels. Brent (the international benchmark) gained improving further $14per bbl, and WTI (a U.S. benchmark) gained almost $8per bbl from January 28 the fiscal outcomes to mid-February, and declining again in March. Conflicting signals on U.S. and current account production trends contributed to rise in oil price volatility. However, amidst ample balance in India global crude oil supply, prices are predicted to remain low in coming months, averaging $53per bbl in 2015 and $57per bbl in 2016. Global inflation, and The sharp fall in oil prices since June 2014 is expected to cut global inflation by monetary policy around 1 percent this year, with some advanced economies seeing a period of outlook remains negative inflation during 2015. Developments in oil prices and inflation continue to favorable at the impact the monetary policy stance (Figure 30). In the Euro Area, several months of moment; and capital deflation, triggered by falling oil prices, could further contribute to a de-anchoring flows to developing of inflation expectations, supporting an aggressive easing of policy. In the U.S. a countries are holding first interest rate hike is expected sometime later this year. Among large oil- importing developing countries, the combined effect of inflation moving towards policy targets, declining current account deficits and soft growth has allowed several central banks to cut interest rates since the start of the year, including Indonesia, Turkey, Romania, Egypt, Pakistan, South Korea, and Thailand. Figure 30: Global inflation is reigning low and Monetary Policy has Been Accommodative in Advanced and Emerging Economies Oil Prices And Global Inflation Monetary Policy Decisions between January 2015 Year-on-year Inflation (LHS) and mid February 2015 Percent Projection (LHS) Number of monetary policy decisions since January 2015 Oil price changes (RHS) 18 5 Emerging markets 80 16 Developed markets 4 14 40 12 3 10 0 2 8 6 1 -40 4 0 -80 2 2010 11 12 13 14 15 16 0 Interest rate cuts Interest rate hikes April 2015 THE WORLD BANK 27 Towards a higher growth path India Development Update Box 5: Remittances to India-Robust growth and resilience to domestic and external shocks Having surpassed the annual volume of portfolio capital flows or official development assistance (ODA), remittances are known to be one of the largest and most stable external flows to developing countries. The World Bank (2014) estimates show that the magnitude of remittances flowing to developing countries increased from $324 billion in 2009 to $454 billion in 2014, and has been growing steadily over the years. After declining by nearly 6 percent in 2009, remittances rebounded quickly to grow at more than 10 percent in 2010, and at 12 percent in 2013. The resilience of remittances has not been uniform across countries though. It has depended crucially on the economic conditions in the host countries where a country’s diaspora population lives; as well as on the kind of economic activities that the diaspora primarily engages in. Remittances could be affected adversely if there is an economic slowdown in the host countries, and particularly if the diaspora works in sectors which are cyclically more volatile, such as construction. Remittances to India have been growing at a steady pace of more than 10 percent a year and have contributed significantly to the balance of payments. India has been the largest recipient of remittances in the world for several years. Looking at the long term trend in remittances that India receives (Figure 31), remittances were quite small up until 1990, but have grown rapidly after that. Their modest magnitude in the period before the 1990s is attributed to the financial and regulatory conditions prevailing at the time. Due to the low level of financial development, high cost and time to remit money, an appreciated rupee under the fixed exchange rate regime, and the restrictions that the central bank imposed on transactions in foreign currency, the flow of remittances was small and a fraction of remittances were routed through the unofficial channels, and not captured in the balance of payment. Several of these conditions changed with the liberalization in early 1990s when the currency was devalued by about 30 percent within a year and was later floated; the current account transactions were liberalized; and the financial liberalization and other technological advancements reduced the time and cost to remit money. Since some of these developments reduced the arbitrage in remitting money through unofficial routes, they were also more fully captured in the balance of payments. Remittances grew at a robust pace of 11 percent a year between 1996 and 2005 (Figure 31). A second spurt in remittances was evident in subsequent years, when they increased at 15 percent a year, consistent with the country’s increased global integration through the trade of goods and services, financial flows as well as the movement of people. Remittances to India have been relatively stable—their annual movement is dominated by a linear trend, with very limited volatility observed around the trend.21 Since a proportion of migrants from India are high skilled, and employed in sectors such as IT, health and education with weak cyclical volatility, the remittances they send home are relatively insulated from the business cycle conditions in their host countries. Remittances are also seen to be somewhat counter cyclical to economic growth in India—they tend to increase during economic slows downs; and possibly when the exchange rate is weak. In recent years, remittances are also seen to be responding to the movements in the domestic and international interest rates, and stock market valuations. In particular, an increase in domestic interest rates; a decline in international interest rates; or an increase in the Indian stock market index, are all seen to be associated with a modest increase in remittances.22 21 Jadhav, Narendra, 2003, “Maximizing Developmental Benefits of Migrant Remittances: The Indian Experience,” and Gupta, Poonam, 2006, “Macroeconomic Determinants of Remittances: Evidence from India”, Economic and Political Weekly show that remittances flows have been more stable than non-resident deposits or portfolio flows. 22Gupta, Poonam, and Karan Singh, 2010, Trends and Correlates of Remittances to India, Migration Letters, Vol. 7 (2), indicate that perhaps just like other financial flows, remittances in recent years are driven partly by an investment motive, and affected by the prospects of relative earnings in the native and host countries. April 2015 THE WORLD BANK 28 Towards a higher growth path India Development Update Figure 31: Remittances picked up in mid 2000s to grow at 15 percent annually; Contributing Significantly to the Balance of Payments 80 Remittances 70 80 Portfolio Foreign Investment 60 60 Non-Resident Deposits 50 Bil.US$ 40 40 30 20 20 10 0 0 -20 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Sources: Reserve Bank of India, and Migration Database, Source: Reserve Bank of India World Bank. The outlook for remittances to India is considered robust, with some downside risks from an economic slowdown in the oil exporting countries in the Middle East and increase in the US interest rate. The World Bank Migration and Development Brief (2014) has predicted a robust outlook for global remittances, as well as for India. Remittances globally are expected to grow at 5 percent in 2014 to $435 billion, and at 4.4 percent to $454 billion in 2015; out of these India is estimated to receive $71 billion in calendar year 2014, increasing to $75 billion in 2015 and $78 billion in 2016. To the extent that remittances are positively associated with the access to banking, the ongoing drive on financial inclusion, under the Jan Dhan Yojana, is likely to facilitate the flows of remittances; while also contributing to consumption smoothing, that remittances are seen to be associated with. The downside risks to this outlook in the medium term include economic slowdown in oil exporting countries in the Middle East, which may impact the demand for expatriate workers in the region (the Middle East region is the largest destination of migrants from India, as indicated in the World Bank’s data on bilateral stock of migrants). Additionally, to the extent that remittances respond to the interest rate differential, an increase in interest rates in the US, may also have a short term negative impact. These adverse impacts are likely to be counterbalanced by India’s improved growth prospects that tend to attract investment-oriented remittances. 9. Outlook and Projections a. Near-term outlook is positive on renewed reform momentum India’s economy is The outlook for the Indian economy is underpinned by two main trends: first, a poised to accelerate relatively benign external environment, particularly low commodity prices, creates in 2015-16 and 2016- policy space; second, a reform program which, if fully implemented, can unlock 17 as the reform investment and boost total factor productivity (TFP) growth. Higher production momentum has capacity, commensurate with capital accumulation and an increase picked up. in total factor-productivity, as well as continued fiscal consolidation, would help curb domestic and external imbalances in the face of rising domestic demand in the medium-term. This outlook is subject to substantial external and domestic risks. Meeting reform targets across the range of policy areas, undertaking wider reforms in factor markets, and scaling up infrastructure would be crucial for attaining the outlook and for the long-term sustainability of growth. April 2015 THE WORLD BANK 29 Towards a higher growth path India Development Update Figure 32: GDP Growth Forecast—Gradual Figure 33: Growth momentum declined in the third Acceleration to Continue assuming Reforms Succeed quarter in Unlocking Private investment GDP growth (market Price) 16.0 Seasonally adjusted GDP 12 14.0 q/q saar 12.0 10 10.0 8.0 8 6.0 6 4.0 2.0 4 0.0 -2.0 2 -4.0 2010-11 2011-12 2012-13 2013-14 2014-15 2015-16 2016-17 2017-18 2011q2 2011q3 2011q4 2012q1 2012q2 2012q3 2012q4 2013q1 2013q2 2013q3 2013q4 2014q1 2014q2 2014q3 2014q4 Source: World Bank staff estimates Note: The X12 ARIMA seasonal adjustments are developed by the US Census Bureau. The adjustemnts are done using the multiplicative method in Eviews, using the default Henderson filter, and without any adjustments for holidays. Real GDP growth (at GDP growth during 2014-15 is estimated at 7.2 percent of GDP (compared to 6.9 market prices) is percent in 2013-14), below the authorities advance estimate of 7.4 percent, largely expected to register on account of some signs of slower momentum in Q3 2014-15. Momentum in most 7.2 percent in 2014- seasonally adjusted series, invariant of specifications, declined in the third quarter 15, accelerating to 7.5 (see Figure 33), as did the y-o-y growth – driving the short term growth forecast.24 percent in 2015-16 However higher frequency information (such as on industrial production) suggest a and further to 8.0 pickup of momentum in the last quarter. Going forward, acceleration in real GDP percent in 2017-1823 growth would be driven largely by higher gross fixed capital formation, which is expected to grow at an average 11 percent annually during FY2016-FY2018 (Figure 34). Simultaneously, growth in government consumption expenditure is expected to increase in 2015-16 on account of an anticipated revision in public salaries under the ambit of the 7th Pay Commission. Private consumption expenditure is expected to respond more gradually and increase to 9 percent by 2017-18 from 6.1 percent in 2014-15. 23 All forecasts are made using the revised (base year, 2011-12) national accounts series. The officially released series is available only from 2011-12. In order to statistically estimate relationships between different variables, a longer back-casted series (up to 1960) was constructed using growth rates. 24 While the seasonal adjustments of a short time series (fifteen observations in the 2011-12 series) are volatile and noisy, the signs of slowing momentum are consistent across specifications. April 2015 THE WORLD BANK 30 Towards a higher growth path India Development Update Figure 34: GDP Growth Forecast is underpinned by Investment picking up, aided by Consumption Growth; Industrial growth would be crucial for Growth Acceleration Private Consumption agriculture industry Government Consumption 14 Services 14 Investment 12 12 10 10 8 8 6 6 4 4 2 2 0 0 2010-11 2011-12 2012-13 2013-14 2014-15 2015-16 2016-17 2017-18 2010-11 2011-12 2012-13 2013-14 2014-15 2015-16 2016-17 2017-18 -2 Source: World Bank staff estimates Much of the pickup If implemented fully, reforms are expected to improve the business environment in GDP growth and alleviate constraints to firm growth. Industrial output is expected to grow at 5.5 would be reflected in percent in 2015-16, and accelerate to 6.4 percent by 2017-18. The services sector, an expansion of the through backward and forward linkages to other sectors of the economy, could industrial sector in grow at an average 10.5 percent during FY2016-FY2018. Agricultural output, response to reform assuming normal rainfall in the forecasting period, is expected to grow at an average measures of 2.8 percent. Household Lower input prices in agriculture may support household consumption in 2015-16, consumption growth but the year is getting off to a weak start due to excess rainfall in many areas. On the is expected to other hand, according to the consumer confidence survey conducted by the central expand along with bank, the future expectations index has increased by 22 percent between December economic activity. 2013 and 2014 – reflecting significantly greater optimism of households and willingness to spend over the coming year. Under the assumption of robust growth as in the baseline, healthy labor market is expected to support household consumption growth to register in at 7.4 percent in 2015-16 and 8.5 percent in 2016-17. Acceleration in fixed These could be expected to accelerate fixed investment growth from 4 percent in investments is 2014-15 to 9 percent in 2015-16 and further to an average of 12.5 percent in predicated on the FY2017-FY2018. While part of the push to investments is expected to come directly successful from the reprioritization of public expenses towards capital formation, investments implementation of are also expected to benefit over-time from the measures adopted by the multiple substantive government to mobilize funds and incentivize infrastructure projects. Some of these reforms. include – encouraging PPP projects through a plug-and-play model which allows private developers to overcome earlier bureaucratic bottlenecks; reforming the business environment to encourage private investment; and incentivizing long-term domestic savings through low inflationary environment and diversified financial instruments. Export growth is While service exports have performed well, the share of Indian merchandise exports constrained in the in world exports has stagnated, and merchandise exports have not contributed to near term by both the recent pickup in growth. While the new government has put a renewed April 2015 THE WORLD BANK 31 Towards a higher growth path India Development Update supply and demand emphasis on increasing India’s merchandise export growth, both supply and conditions. demand factors constrain the potential expansion of exports in near term. On the supply side, the Indian industrial sector has barely kept up with its global competitors as evidenced by India’s stagnant share of global exports; while on the demand-side, the share of world exports to world GDP seems to have peaked (Figure 35). It would take a level increase in the competitiveness of the Indian manufacturing for it to carve a space for itself among the existing large exporters, within a market that seems to have peaked out. Although exports of services remain a bright spot and expected to continue to post double-digit growth in the medium-term, merchandise exports, similar to manufacturing output, are only likely to expand meaningfully once investments and productivity-enhancing reforms to labor, land, and capital markets are realized Figure 35: Growth prospects of the world trade are subdued. After increasing far more rapidly than the global GDP until 2007, global trade has been growing at a slower pace than before World: GDP World: Trade World: Merchandise Trade, Annual Growth 600 25 20 % Change - Year to Year 500 15 10 Index 1993=100 400 5 0 300 -5 200 -10 -15 100 -20 -25 0 -30 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 Source: World Bank. Successful While data constraints make it difficult to estimate potential GDP with precision, implementation of we estimate potential growth to nearly converge to 8 percent by 2017-18, from productivity- around 7 percent in 2013-14, assuming both a meaningful and sustainable pick-up in enhancing reforms investment to increase capacity in the economy, as well as a pick-up in productivity would be expected to growth. Commensurate with greater efficiency on account of the announced boost India’s reforms, growth in total factor productivity is expected to accelerate during the potential GDP25 forecasting period, approximately 30 bps higher than that in the previous decade. Under the baseline Lower crude prices (which account for 6.8 percent in the consumer price index) scenario, inflationary would likely have spillover effects to food inflation; the improved production pressures are likely capacity drawing from the pickup in investment could prevent overheating in the to remain contained medium-term (although a positive output gap is expected into 2017-18); and the recently adopted inflation targeting framework is likely to keep inflationary expectations anchored. In the baseline scenario, inflation is likely to decelerate to below 5 percent by 2017-18, approaching the RBI’s target of 4 percent, with a band 25Estimates for potential GDP growth are based on a standard production function with labor and capital shares held at 0.7 and 0.3 percent respectively. Capital stock estimates from the old (base-year: 2004-05) national accounts series – have been converted to the new series using the relationship between the flow of capital formation in the new and old series. Labor force estimates are from the UN population projections. April 2015 THE WORLD BANK 32 Towards a higher growth path India Development Update of two percent around it. Some upside risks on food prices (with 46 percent weight in the CPI) may arise in the event of poor monsoons, unanticipated large increases in the minimum support price of food grains, or increase in oil prices. The current account The current account deficit is expected to narrow from 1.8 percent of GDP in deficit is expected to 2013-14 to 0.7 percent of GDP in 2014-15 due to lower value of crude imports narrow in the near- (which account for more than one-third of total merchandise imports), but could term but widen widen somewhat in later years as imports of capital and intermediate goods somewhat as accelerate in line with the expectation of a pick-up in investment. Expanding investment growth domestic capacity and unlocking constraints to faster export growth would be picks up crucial to ensuring the medium-term stability of the current account as well. b. There are substantial external as well as domestic risks to the outlook Effective policy While the government has embarked on energetic reform efforts across several implementation on areas, the current scope and pace of policy efforts may not prove adequate to many challenging unleash productivity and scale enhancement needed for the Indian firms to become fronts is required to globally competitive. As has been suggested by others, devolving more space to the realize the increase states in some of the policy areas may produce enclaves of competitiveness and in investments garner further support for wider reforms among the population and political classes embodied in the across India. Should risks to the outlook materialize, especially with respect to baseline scenario investment-enhancing reforms, the growth rate could turn out to be significantly lower. The potential growth rate could be reduced in a “business as usual” scenario which restricts the growth in productivity, investments and industrial output at the last five year average, to below 7 percent by 2016-17. To achieve the These include containment of current expenditures, especially food and fertilizer planned acceleration subsidies; delivering on divestment plans, which has been a challenge in the past; in public and ensuring greater tax buoyancy than has been realized lately. Without parallel investments, the efforts on all these fronts, resource constraints may continue to limit public capital government will expenditures, as in the past. Effective implementation of the reforms to the PPP need to implement process would also be critical, while reforms to the business environment that have fiscal measures that been initiated and are expected to be deepened further are also salient. Finally, given protect infrastructure the larger devolution of tax revenue to the states, their efforts in boosting funding investments would also be important. Within policy-related Measures to address the debt overhang and public sector bank’s recapitalization challenges to would be required to achieve the pick-up in investments assumed in the baseline accelerate scenario. While some measures have been announced recently, including greater investment, perhaps functional autonomy and strengthened management practices, recapitalization of the most significant selected banks through budgetary support, or equity market; more decisive measures stems from the would need to be taken given the underlying magnitude of recapitalization banking sector requirement and other medium term ownership related issues. The recent economic The recent decline in inflation; reduction in current account deficit; and the fiscal turnaround as well as space freed up by lower oil subsidies, stem from the recent decline in the the outlook rests international prices of oil, metals and food. These positive dynamics could unravel crucially on oil and at least partially if prices fail to stay low, reinforcing the imperative for the commodity prices government to insulate the economy more determinedly from the global price of oil. remaining close to This could be done by weaning fiscal outcomes more fully from oil prices, by current levels building in rules or procedures for domestic prices to align automatically with the import prices; by reducing the oil-intensity of the economy and encouraging alternative sources of energy including by mulling the possibility of using petroleum April 2015 THE WORLD BANK 33 Towards a higher growth path India Development Update taxation more actively; and by appropriating the current sweet spot moment to further rationalize the still high levels of subsidies on food and fertilizer. India remains at risk Even though the Federal Reserve Board has maintained its stance on monetary of disruptive impact policy, the broad expectations are that it would start tightening it sometime in 2015, of potential and possibly as early as in summer, 2015. India being one of the larger financial tightening of the US markets, and a large recipient of capital flows, could be adversely affected by a monetary policy on rebalancing triggered by the tightening of the Fed’s monetary policy. While the its exchange rate and Reserve Bank of India has taken preventive measures to reduce external financial markets vulnerability, and has built international buffers as a “first line of defense”, the risk remains, warranting vigilance. Weather risks remain Although 2016 is expected to be a normal monsoon year, the effect of a poor relevant monsoon (defined as rainfall below normal) season could lead to increases in food prices inflation of up to 0.5 percentage points, while reducing the agricultural output growth by 0.3 percent. April 2015 THE WORLD BANK 34 Towards a higher growth path India Development Update B. Selected Issues cline in Oil Process and 1. Dec nities for Ind d Opportun dia p Global oil prices have fal by nearly 60 p llen sharply, b percent, to bel low US$50 pe er bbl, between Jun F ne 2014 and February 2015 5 (Figure 36). The decline is ibuted s broadly attri ve supply shoc to a positiv ck—the expan nsion of shalee oil output inn the United S States, and OPEC’ ’s decision to maintain its m market share; a some moderat as well as to s tion in global dema c and, due to continuing subbdued global growth, and a decline in t the oil f production and intensity of a consumpt tion. The Wor rld Bank expe ects lower oil prices (US$53/bbl n 2015 and to r l) to persist in ginally in 2016 rise only marg 6 (US$57/bbl) ).26 The decline s is expected to have signi e in oil prices ificant macroe economic, finnancial and policy implications across countr ries. The effects would dif nal on ffer, condition whether a country is a net oil expo orter or impo orter; the ener rgy intensity of its production; ; and the tax and subs sidies that a apply on the e production n and consumptio on of oil prod ducts. On ave erage, the dec rices is expect cline in oil pr ted to support eco onomic growt ation, improv th, lower infla ve current acc count balancees and pace in oil-imp the fiscal sp porting countrries; while the oil-exporting e likely g countries are to see wea akening fiscal l and externnal positions and negative e impact on their a economic activity. The overall econoomic impact, after netting out these co ountry specific effe ated to be po ects, is estima ositive. Accord ding to the W World Bank, t the oil price declinne could increa DP by 0.7-0.8 p ase global GD percent over tthe medium te erm.27 26Commodity y Markets Outloook, March 2015 27World Bank ch Note, 2015, “ k, Policy Researc ge in Oil Prices: Causes, Conseq “The Great Plung quences, sponses”. and Policy Res April 2015 THE WORLD BANK 35 Towards a higher growth path India Development Update Figure 36: International oil price has declined sharply since mid-2014 and is reflected in a decline in the import price of Indian oil Basket Price of Oil Crude Oil Price (Indian Basket) (US$ per barrel) (US$ per barrel) 140 140 120 120 100 100 80 80 60 60 40 40 20 20 May-10 May-11 May-12 May-13 May-14 Jan-10 Sep-10 Jan-11 Sep-11 Jan-12 Sep-12 Jan-13 Sep-13 Jan-14 Sep-14 Jan-15 May-10 May-11 May-12 May-13 May-14 Jan-10 Sep-10 Jan-11 Sep-11 Jan-12 Sep-12 Jan-13 Sep-13 Jan-14 Sep-14 Jan-15 Source: IFS; Ministry of Petroleum and Natural Gas, India India being a net importer of crude oil, the impact on the Indian economy has been positive thus far. It has reflected in a modest improvement in the current account balance, some moderation in inflation, and crucially, in lower fuel subsidies and enhanced fiscal space. The government used the opportunity offered by low crude oil prices to increase excise tax rates on petrol and diesel, which is likely to further add to the fiscal space through enhanced tax collection. a. India has benefitted on several fronts from the decline in global crude prices (i) India, being a net importer of petroleum products, the decline in oil prices has helped reduce its trade deficit India is a net importer of petroleum products. It meets more than three-fourths of its demand for crude oil through imports; which account for about 30 percent of all its merchandise imports. It is also a large producer and exporter of refined petroleum–accounting for nearly 20 percent of the total merchandise exports. In recent years, FY2012-FY2014, net imports of petroleum have averaged $100 billion a year. The petroleum import bill is sensitive to the movements in the exchange rate as well as the import price of oil. Oil and Petroleum Ministry’s has estimated that an exchange rate depreciation of INR 1 per $ increases the net import bill by nearly $0.19 bn, and an increase in the price of crude oil by 1 $ per bbl, increases the net import bill by $0.24 bn. Hence unsurprisingly, as global crude prices started declining in June 2014, amidst relatively stable exchange rate, India’s net import bill declined. The net impact has been a decline in trade deficit on petroleum products equal to about $2 billion during the three quarters of the current year (Figure 37). April 2015 THE WORLD BANK 36 Towards a higher growth path India Development Update Figure 37: India Imports Crude Oil and Exports Refined Oil and runs a Significant Trade Deficit on Petroleum Products; the Trade Deficit has declined due to the decline in oil prices Export Import Export Import Net Trade 18 200 155.0 164.0 164.8 16 14 150 12 100 Bil.US$ 56.0 60.9 63.2 10 8 50 Bil.US$ 6 0 4 2 -50 0 -100 Apr-12 Oct-12 Oct-13 Oct-14 Jan-12 Jul-12 Jan-13 Apr-13 Jul-13 Jan-14 Apr-14 Jul-14 Jan-15 -98.9 -103.2 -101.5 -150 Apr-Dec 2012 Apr-Dec 2013 Apr-Dec 2014 Source: Ministry of Commerce, India (ii) Decline in Oil prices has helped lower Fuel Subsidies, Generating some Fiscal Space The marketing and retail of petroleum products in India has heavy involvement of public sector enterprises at all levels of the value chain –extraction of crude oil and natural gas (upstream activities); refining of crude oil and the retail and distribution (downstream activities). The consumption of petroleum products is dominated by four products—petrol, diesel, kerosene and liquefied petroleum gas (LPG); with variants within each of these products—e.g. branded and unbranded diesel and petrol; kerosene sold through the PDS or in the open market; and the LPG used for domestic or commercial use. The pricing mechanism, subsidies and taxes differ across these different products and their variants. Until recently, the retail prices of petroleum products were administered by the central government; and the prices were set at below the cost recovery level, resulting in losses to the Oil Marketing Companies (OMCs). These under- recoveries, are borne by the central government (2/3rd of under-recoveries, in the form of petroleum subsidies) and upstream companies (1/3rd of under-recoveries). In 2013-14, OMCs incurred under-recoveries of approximately INR1.4 trillion (1.2 percent of GDP), and the government’s share (equivalent to fuel subsidy) was 0.8 percent of GDP. There have been efforts recently to link the retail prices of petrol and diesel more closely with their cost of production. Petrol prices were deregulated in June 2010, and currently vary with the trade parity price. Diesel prices were partially deregulated in 2013 when the OMCs were allowed to raise retail diesel prices by INR 0.50 per liter per month until their losses were recovered, and were fully deregulated in October 2014 (Figure 38). Due to these changes and the decline in the price of oil, under-recoveries incurred by OMCs have moderated, not just in deregulated diesel but also on kerosene and LPG, prices of which continue to be regulated. These are reflected in the government’s fuel subsidy bill declining from 0.8 percent of GDP in the previous year to 0.5 percent of GDP during 2014-15. With the deregulated prices of petrol and diesel, and the low crude prices prevailing, the subsidy bill is expected to decline further to 0.2 percent in 2015-16 (the Budget estimates). April 2015 THE WORLD BANK 37 Towards a higher growth path India Development Update : After Increas Figure 38: vely in the mid-2000s, Savin sing Impressiv stment Ratios have declined ngs and Inves d, and i not yet in Si Rebound is ight Diesel Under-recoveries (Rs/Litre) Per Unit under P r-recovery Crude oil, average $/bbl (RHS) ( kg) Dom estic LPG (INR/k 16 1 120 800 S, INR/litre) PDS Kerosene (RHS 40 14 12 1 110 700 35 10 100 1 600 8 30 6 500 9 90 25 4 400 Complete 2 20 Phased deregulation 8 80 300 0 deregulation Nov-12 Mar-13 May-13 Sep-13 Nov-13 Mar-14 May-14 Sep-14 Nov-14 Jan-13 Jul-13 Jan-14 Jul-14 -2 7 70 200 15 p Jan-15 Jan 15 Jan-12 Jan-13 Jan-14 Oct-14 Apr-11 Oct-11 Apr-12 Oct-12 Oct-13 Jul-11 Jul-12 Apr-13 Apr-14 Jul-13 Jul-14 -4 -6 6 60 nistry of Petrole Source: Min al Gas, India eum and Natura Even thoug k gh LPG and kerosene remaiin subsidized and their pricces are still at a level that results in under rec covery of cossts; the gover rnment has t tried to restrict the amount of subsidy availe ed on LPG by y lowering the e number of ssubsidized cyli inders per family. In 2013, the number of s ubsidized cyli inders was reduced to nine e; and more recent ather than sub sidizing the cy tly in 2014, ra ont, the govern ylinders upfro nment has sought to sell them at market pr rices, and traansfer the subbsidy to consu umers through cassh payment on ders per year.2 n twelve cylind 28 U Table 6: Under ries on Diesel and Petrol ha Recover d but persist on ave eliminated erosene n LPG and Ke 2013-14 013 Apri l-December 20 ril-December 2 Apr 2014 Per Un overy (INR pe nit Under Reco nder) er Liter or Cylin Diesel 8.39 8.49 2.70* KO PDS SK 33.98 33.12 31.69 Domestic LPG 499.52 440.39 428.31 er Recovery (IN Total Unde NR billion) Diesel 628.37 476.55 109.35* KO PDS SK 305.75 223.73 212.16 Domestic LPG 464.58 306.04 349.41 Total 1398.69 1006.32 670.91 regulated from 19th October, 2014 Note: *Der 2 inistry of Petrole Source: Mi ral Gas, India eum and Natur t Following their deregula ail prices of d ation, the reta trol have kept diesel and pet t pace with the inc p crease in oil prices ey are smooth (Figure 39), albeit the mport her than the im ass through ha price; the pa as been much h lower for kerrosene and LPPG prices. 28 The Center r commenced the e Modified Direc ct Benefit Trans sfer Scheme for cooking gas (DB BTL) in November 20 014. Under the scheme, consume ers would purch hase LPG cookin t prices ng fuel at market s and receive the requisite cash subsidy n their registered directly in d bank accounts. The scheme cov vered 54 w extended to another 246 distr districts in its first phase, and was ry 2015. The con ricts from Januar nsumers who do not wishw to avail the su ubsidies can voluuntarily opt out. April 2015 THE WORLD BANK 38 Towards a higher growth path India Development Update Figure 39: Retail prices of Petrol and Diesel Correlate with the Import price; but Kerosene and LPG prices do not Crude Oil Price (Indian Basket) Crude Oil I mport Price (Indian Basket) Superior Kerosene Oil Retail Price: Petrol (Delhi) Liquified Petroleum Gas: (14.2 Kg Cylinder) Retail Price: Diesel (Delhi) 300 180 250 160 Index,2004-05=100 Index, Jan-2010=100 140 200 120 150 100 100 80 50 60 0 40 May-10 May-11 May-12 May-13 May-14 Jan-10 Sep-10 Jan-11 Sep-11 Jan-12 Sep-12 Jan-13 Sep-13 Jan-14 Sep-14 Jan-15 2004- 2005- 2006- 2007- 2008- 2009- 2010- 2011- 2012- 2013- 05 06 07 08 09 10 11 12 13 14 Source: Petroleum Planning and Analysis Cell and Indian Oil Corporation Ltd., India (iii) Government Seized the Opportunity offered by low oil Price to Increase Taxes on Petrol and Diesel, further adding to the Fiscal Space Various petroleum products attract different taxes from the Central and State governments, Table 7. While the Central Government collects customs duty (ad valorem) and excise revenue (per unit of sale); states impose the sales tax/VAT, with rates differing substantially across states. An example of how these various taxes get reflected in the retail prices is in Table 8. Table 7: Customs and Center Excise Duty on Petrol and Diesel as of January 2015 Customs Excise (INR/Liter) INR 17.46/liter (works out to nearly 30 % of the retail Petrol 2.5% price in Delhi) INR 10.26/liter (works out to nearly 22 % of the retail Diesel 2.5% price in Delhi) Non PDS Kerosene 5% 14% Non Domestic LPG 5% 8% Source: Petroleum Planning and Analysis Cell, India Table 8: Break up of Retail Price of Petrol and Diesel in Delhi in end January 2015 (INR/Liter) Product Petrol Diesel Price before taxes and dealer commission 27.82 29.14 Central Taxes 17.96 10.80 State Taxes 9.55 5.43 Dealer Commission 1.99 1.25 Retail Selling Price 57.31 46.62 Source: Petroleum Planning and Analysis Cell, India Leveraging the decline in international crude prices, the government raised excise duties on petrol and diesel multiple times between mid-November, 2014 and mid- January, 2015, as indicated in Table 9 below. While there are no precise estimates of additional excise revenues expected to be generated from these hikes, some estimates reported in the media suggest additional revenues could be around INR 200 billion during 2014-15, and perhaps much larger the next year. April 2015 THE WORLD BANK 39 Towards a higher growth path India Development Update Table 9: Increase in Excise duty on Diesel and Petrol between November, 2014-February, 2015 Diesel Petrol Excise Level Before November 14, 2014 (per liter) 1.46 1.20 Increases in Excise Rates (per liter) November 14, 2014 1.5 1.5 December 2, 2014 1 2.25 Jan 1, 2015 2 2 Jan 16, 2015 2 2 Source: Government announcements (iv) Decline in Oil prices also made a Modest Contribution to lowering Inflation Impact of the decline in global oil prices on inflation in India depends on the transmission of international prices to retail prices, and any changes in the State and Center taxes and subsidies, as well as the weight of petroleum products in the inflation index. After accounting for taxes and subsidies, decline in global crude oil price led to a moderation in retail fuel inflation to 3.4 percent yoy during Oct 2014- Jan 2015, though its contribution to the overall decline in CPI was rather modest due to its low weight in the CPI index.29 A decomposition of the decline in CPI inflation during April 2014-Jan 2015 showed that of the 3.10 percentage points decline in inflation over the same period, previous year only a 20 bps decline (0.2 percentage point) was contributed by the decline in fuel prices. b. The decline in oil prices helped generate important fiscal and current account savings; but the opportunity could be seized to deepen price and subsidy reforms and generate durable policy buffers The recent decline in oil prices has generated net benefits for the economy, and has been partly responsible for the recent turnaround in the economic narrative, underpinned by a decline in inflation; reduction in current account deficit; and the fiscal space freed up by lower oil subsidies. Low oil prices have presented the government with a unique opportunity to insulate the economy more determinedly from the global price of oil, while generating larger resources to enhance public investment on infrastructure. This has been done by deregulating prices to move with the import parity price, and by increasing taxes on petrol and diesel; while improving the delivery of fuel subsidies on LPG. These efforts could be reinforced further by weaning fiscal outcomes more fully from oil prices; reducing the intensity of economic activity to imported oil, while encouraging alternative sources of energy; as well as mulling the possibility of creating additional fiscal buffers by using petroleum taxation more actively; and by appropriating the current “sweet spot” moment to further rationalize the still high levels of subsidies on food and fertilizer. 29 The weight of fuel and light in the CPI basket (combined rural and urban) is 6.8 percent, and petroleum products being a component of this category, the direct weight of petroleum product is lower. However to the extent that petroleum prices affect other components in the consumption basket, particularly transport (which is clubbed in another category with communication), we use 6.8 percent weight for the price of petroleum products in the basket. April 2015 THE WORLD BANK 40 Towards a higher growth path India Development Update M S cost-effecti 2. Is MGNREGS poverty? ive against p The Nation nal Rural Emp ployment Guar arantee Act, paassed in 2005,, guarantees too each rural househhold 100 days s of work perr year on local l public works. Nearly ten n years into its ex xistence, the sheer scale of the Mah hatma Gandhi National Rural Employmen nt Guarantee Scheme (MG GNREGS) is i With over 50 m impressive. W million beneficiary households, and expendiitures betwee en 0.5 and 1 1% of GDP, , it is amongst the largest anti-p poverty progr world.30 Yet th rams in the w he jury is still out as to whether the program has been effe ucing rural po fective in redu overty, and wh hether p alternative policies, ash transfers w such as universal ca would be mor re cost-effectivve. a. The Promise of Workfare MGNREGS has the pot tential to reduuce poverty inn several way ys. The most direct route is by providing extra employme ent and incom me to the poo orest in rural areas. Such workf fare schemes are built on t the assumptio he poorest wh on that it is th ho will i them, and that people w participate in urn away from will readily tu m the scheme when better oppo e. In other w ortunities arise words, workfar re schemes ar ed and re self-targete i implemente therefore, cost-effective if ed well. Second, thee scheme can reduce pover rty by creating lue to poor people, g assets of val either direectly or indi irectly, by g generating jo obs through creating ess sential ure such as rur infrastructu can, in turn, su ral roads that c upport privatee enterprises. Other indir rect channels of impact c can also be e expected. It can provide e rural b laborers a bargaining chi egotiations wi ip in wage ne ith private emmployers. Thi is can, y at least, allow theoretically w them to seccure higher w ties of wage rates for similar activit casual laborr, thus benefit even if they d tting workers e ate in the scheme. A don’t participa 30 ebsite nrega.nic Official we c.in April 2015 THE WORLD BANK 41 Towards a higher growth path India Development Update guarantee of employment can also provide crucial insurance benefits against shocks. There may be other non-pecuniary benefits to participants: it could provide someone with a viable alternative to working for the local landowner, thus empowering them in other ways. If these benefits were to be realized, the scheme has the potential to drastically cut poverty. Analysis of household survey data from Bihar shows that under ideal conditions, the rural poverty rate of 50% at the time of the survey could come down by at least 14 percentage points.31 In an ideal world, everyone who wants work should get it, up to 100 days per household per year, at the stipulated wage rates, without having to give up any other employment opportunity to take up the work. If anything, this is an underestimate because it ignores spillover effects to casual wage rates for other unskilled work; it also ignores other indirect impacts on poverty stemming from the creation of assets that could support economic activity such as rural roads or check dams to improve agricultural productivity. b. Debates about MGNREGS In reality, the performance record is mixed. Paradoxically, the scheme has worked less well in poorer states, where it is needed the most. At one end of the spectrum, the scheme is shown to have delivered significant positive impacts on a range of outcomes -- from consumption and nutrition, to quality assets and productivity improvements, particularly for the poorest – in Andhra Pradesh.32 At the other end, impacts of the scheme in Bihar fall far short of potential. Compared to a potential reduction in poverty by 14 percentage points, actual impact on rural poverty is only about 1 percentage point.33 It is against the backdrop of a mixed record that debate has arisen recently about how effective MGNREGS can be in reducing poverty. There are two strands of thought on the future of the program. One strand turns on issues of program implementation—what are the key bottlenecks that hold back impact; and what will it take for the scheme to work better, particularly in the poorest areas? Much has been written about how the program could be made more effective by systematically building awareness, employing tools of e-governance, community- based monitoring, and strengthening local capacity. Dovetailing MGNREGS with other schemes to create productive community assets is another area of possible emphasis. The other strand of thought questions the very rationale of the scheme, asking whether it is inherently cumbersome and if there aren’t simpler alternatives to achieve similar poverty reduction objectives within the same budget. Advocates of this stream of thinking envision India’s social protection system moving towards a universal cash transfer, or basic-income support (BIS) scheme, that guarantees a fixed cash transfer to every person, whether poor or not. Drives to open bank accounts (most recently, under the Jan Dhan Yojana), the system of national identity cards (Aadhaar), combined with near-ubiquitous mobile technology – the so-called “JAM trinity” -- can pave the way for such a scheme. 31 Dutta et al. (2014) 32Deininger and Liu (2013) 33 Estimate from Dutta et al (2014) based on a survey of over 2700 rural households in Bihar in 2009 and 2010. The sample was representative of rural Bihar. April 2015 THE WORLD BANK 42 Towards a higher growth path India Development Update Whether or not MGNREGS is more cost-effective than an alternative such as a BIS scheme depends on how well either is implemented. So the two strands outlined above are closely interlinked. In the remainder of this section, we draw on lessons from Bihar and other states to bring evidence to bear on these debates. c. Performance of MGNREGS: Explaining the Gap between Potential and Practice There are a number of reasons why the potential impact of MGNREGS may not be realized in practice: the supply side may be slow to respond to the demand for work on the scheme, leaving un-met demand (rationing); workers may be unable to meet productivity norms for earning the minimum wage; there may be delays in wage payments; corruption at different steps could hold back the program; and assets created may not be durable and productive. Understanding the relative importance of different factors helps to direct attention to the key bottlenecks in implementation. In Bihar, more than two-thirds – about 10 percentage points – of the gap between potential and actual impacts is attributable to the ways in which the scheme is not fulfilling the provisions of the Act. The rest is due to the foregone income, i.e., an opportunity cost to the worker from giving up alternate employment in order to take up MGNREGS work. Forgone incomes are hard to avoid, but are important to the calculus when evaluating the net income gains from MGNREGS participation and its cost- effectiveness against other alternatives (as discussed further in the next section). High levels of unmet demand for work on the scheme constrain poverty impacts If MGNREGS worked in practice the way it is designed, there would be no unmet demand for work. At an All India level, 2009-10 National Sample Survey (NSS) data show a great deal of unmet demand.34 46% of households report that one or more members of their household would have liked to work on the scheme; only 25% secured any work over the course of the year. Participation rates in the scheme are not, as a rule, any higher in poorer states. There is greater demand for work on the scheme in poorer states, but also a lower capacity to meet that demand (Figure 40). As a result, the degree of unmet demand or rationing, i.e., the fraction of people who wanted work but did not get it, is bigger in the poorer states. In Bihar, unmet demand alone accounts for nearly three-fifths of the gap between potential and realized poverty impacts. 34 Administrative data indicate virtually no unmet demand for work on MGNREGS. This is deceptive because what is called “demand for work” in these data is the official registration of demand. A better measure of demand is available in the NSS which asks respondents if anyone in their household got work, sought but did not get work, or did not seek work on the scheme. April 2015 THE WORLD BANK 43 Towards a higher growth path India Development Update Figure 40: Demand for MGNREGS work is greater in poorer states, but participation rates are not Demand rate for MGNREGS (share of rural households) Participation rate in M GNREGS (share of rural households) .8 .7 r=0.50 r=0.13 Rajasthan .7 .6 Rajasthan Chhattisgarh .5 .6 Chhattisgarh .4 .5 Bihar .3 .4 .2 .3 Kerala .1 .2 Bihar Haryana .0 .1 10 15 20 25 30 35 40 45 50 55 60 10 15 20 25 30 35 40 45 50 55 60 Headcount index of rural poverty 2009/10 (% below poverty line) Headcount index of rural poverty 2009/10 (% below poverty line) Note: Participation rate is the share of rural households working on MGNREGS. The demand rate is the share of rural households that want work on the program. Estimates based on National Sample Survey 2009/10. Source: Dutta et. al. (2012). High rationing weakens labor market responses to the scheme The extent of rationing has important implications for the scheme. It makes the scheme a less credible fallback position for the rural laborer seeking work, and limits the spillover effects onto the private wage-labor market. It also undermines the insurance benefits of the scheme, which depend crucially on workers being able to turn to the scheme when it is needed. There are many anecdotal observations of MGNREGS contributing to a steep rise in wages for unskilled labor. Studies of the impacts of the scheme on market wages for unskilled labor produce mixed results. Zimmerman (2013) finds little evidence of any labor market effects. Berg et al. (2012) and Imbert and Papp (2013) find positive effects on wages, but only in states where implementation is of high quality and intensity, and hence where the demand for work is more likely to be met. Azam (2012) finds wage impacts but only for women. The Bihar survey shows that market wages have been catching up with the MGNREGS wage but do not respond in a predictable pattern to changes in the stipulated wage for the scheme. Leakage is substantial even though it is nowhere near as large as some casual observers have claimed Despite government’s efforts to promote transparency and encourage monitoring from administration and civil society (social audits), MGNREGS is plagued by leakages. Leakage can take multiple forms, such as inflating the number of days worked per person, or registering fake persons to siphon off funds. Comparison of MGNREGS aggregate levels of employment reported in official data with independent measures based on household surveys show that the gap exists, but the range of available estimates is too wide to be conclusive. NSS-based estimates for 2007-08 can confirm only a quarter to half of MGNREGS employment recorded in official reports, depending on the method used.35 Specialized surveys with more 35The approach of estimating leakages by the shortfall in estimated total employment relative to days of employment recorded in the administrative data has been used in the literature (Bhalla 2011, April 2015 THE WORLD BANK 44 Towards a higher growth path India Development Update detailed questions on participation and remuneration in the scheme suggest substantially lower estimates of leakage. For instance, the Bihar survey of MGNREGS implies a 20% gap between survey-based estimates of employment and official data in 2008-09 compared to the 2007-08 NSS-based estimate of 70% gap in the state. From wage gaps to payment delays – the nature of bottlenecks have evolved over time Discrepancies between the scheme’s stipulated wage rates and actual wages received by workers also contribute to the gap between potential and realized impacts. In Bihar, on average, workers on the scheme received about 10% lower wages than the stipulated rate. This gap is not due to payment delays, as the gaps are estimated on total wages owed to the individual, not the amount actually received by the time of the survey. More recently, payment delays have emerged as a major bottleneck in program administration, and are a strong disincentive to participating in the program. National surveys highlight variation amongst states – in 2009/10 a survey found nearly 68% of MGNREGS beneficiaries received wages within 15 days in Andhra Pradesh. The same estimate for Rajasthan and MP were 10% and 23%.36 d. Stacking-up MGNREGS against a Cash Transfer How do the impacts of MGNREGS, as implemented today, compare to the potential impacts of a universal cash transfer based on the same aggregate budget? MGNREGS attains better targeting than a universal cash transfer. However, it entails higher costs. In a Basic Income Scheme, there is no explicit effort at targeting or reaching only, or even primarily, the poorest. MGNREGS, by contrast, has an in-built self- targeting mechanism and most studies show that despite the substantial unmet demand, participation in the scheme favors people from poorer families. Greater participation by the poor reflects both higher demand for work on the scheme amongst poorer households, and a rationing process that is pro-poor. Relative to workfare, BIS holds two cost advantages. First, workfare schemes incur non-negligible other costs that would not be spent in alternative cash transfer schemes. Public works require outlays on material inputs as well as on hiring relatively skilled labor for organizing and supervising the worksites. Even in the highly unskilled-labor intensive schemes seen in South Asia, these “non-wage” costs account for about one-third of the public outlay. Administrative costs of a cash transfer scheme can be expected to be lower, particularly if transfers are automated after an identity and financial infrastructure is in place. An added cost of workfare, relative to a BIS scheme, is borne by participants themselves. If participants have to give up other employment opportunities in order to work on the scheme, net gains from participation will be lower than the scheme wage, with implications for eventual impact on poverty. As a result, workfare tends to be advocated in places, or at times, with high unemployment, such as during Himanshu 2010, Imbert 2015). It is a crude estimate which depends on the accuracy of the survey- based estimates and of the administrative data. 36 NSSO (2011) April 2015 THE WORLD BANK 45 Towards a higher growth path India Development Update recessions, famines or lean agricultural seasons. Advocates of workfare schemes often assume (explicitly or implicitly) that workers would be idle in the absence of the scheme. Whether or not the assumption of zero alternative employment opportunities and income is plausible depends on the context. In Bihar, while alternative opportunities that MGNREGS participants give up to work on the scheme are less remunerative, forgone income is nonetheless significant. Even with better targeting, MGNREGS would not be cost-effective unless assets created are of sufficient value Factoring in forgone incomes and non-wage costs, and focusing only on the wage gains, the Bihar study finds that MGNREGS has less impact on poverty than a universal cash transfer would have had based on an equivalent aggregate budget. The simulations assume that in the cash transfer scheme, every household (whether poor or not) is given their share of the same sum of money as was spent on MGNREGS. However, this comparison does not take account of the asset creation under MGNREGS, or other potential non-pecuniary benefits. The simulations ask whether the wage earnings alone can justify the scheme as a more cost-effective means of reducing poverty, relative to a cash transfer. The results show that even if forgone incomes are substantially overestimated, a cash transfer dominates; results are also robust to the choice of poverty line over a wide range. A cash transfer is still an improvement over MGNREGS even if it is assumed to have the same extent of leakage or administrative costs. In sum, even though MGNREGS is better targeted than a cash transfer scheme would be, wage earnings alone are not sufficient to make it more cost-effective at reducing poverty. But, it could be, if the assets created under it are of sufficient value to the poor. Other non-pecuniary benefits – like empowerment for socially vulnerable groups including women -- would further strengthen the case for workfare. e. Two Directions for Reform Can the scheme be reformed to work better in practice? Forgone incomes are not easily controlled by such a program. The gaps between the stipulated wage rates and wages received, and payment delays might be reduced. Pro-poor reform could also reduce the substantial unmet demand for work on the scheme. This could be done by enhanced public information and a more responsive supply side. These would enhance the impact on poverty, including through larger impacts on wages in the private casual labor market. The greater impact on poverty would come at a greater cost to the public budget. Cost effectiveness would need to be re-assessed at the implied higher level of funding. Growing experimentation and experience across states, particularly in the use of information technology or e-governance, has produced promising results. Investment in tightening up program administration, fund flows, and transparency safeguards has yielded a reduction in program leakage (Dréze 2014, Imbert 2015), reflected in reduced nation-wide leakage estimates between 2009-10 and 2011-12 in the NSS data, and much lower estimates from the India Human Development Survey. Studies in Bihar and Andhra Pradesh (Banerjee et al. 2014, Muralidharan et al. 2014) highlight how re-engineering fund-flows through use of technology can reduce leakage and improve wage payment processes at the last-mile. The use of biometric identification yielded a 35% drop in leakage levels for the program in Andhra Pradesh. April 2015 THE WORLD BANK 46 Towards a higher growth path India Development Update A second, and complementary, direction for reforms is to ensure that workfare is productive—that the assets created are of value to poor people (or that cost- recovery can be implemented for non-poor beneficiaries). This is a vital ingredient to the success of the program. The on-going efforts at convergence of the scheme with other programs to build a range of assets are steps in that direction. Policy choices may well need to confront a trade-off. Depending on the types of works, meeting the extra demand for work may make it harder to assure that the assets are indeed of lasting value. The public choice made in response to such a trade-off will depend on the weight attached to reducing current versus future poverty. April 2015 THE WORLD BANK 47 Towards a higher growth path India Development Update REFERENCES Azam, Mehtabul, 2012, “The Impact of Indian Job Guarantee Scheme on Labor Market Outcomes: Evidence from a Natural Experiment,” IZA Discussion Paper No. 6548, Bonn, Germany. Banerjee, Abhijit V, Esther Duflo, Clement Imbert, Rohini Pande, and Mathew Santhosh. 2014. "Can E- Governance Reduce Capture of Public Programs? Experimental Evidence from a Financial Reform of India's Employment Guarantee." Manuscript. Berg, Erlend, Sambit Bhattacharyya, Rajasekhar Durgam and Manjula Ramachandra, 2012, “Can Rural Public Works Affect Agricultural Wages? Evidence from India,” Center for the Study of African Economies Working Paper Series 2012-05, University of Oxford, Oxford, U.K. Bhalla, Surjit. 2011. “Does NREGA Really Work?” Business Standard, March 27. Deininger, Klaus, and Yanyan Liu. 2013. “Welfare and Poverty Impacts of India's National Rural Employment Guarantee: Evidence from Andhra Pradesh.” Policy Research Working Paper 6543, World Bank, Washington DC. Dréze, Jean. 2014. “Learning from NREGA.” The Hindu, 20 August. Dutta, Puja, Rinku Murgai, Martin Ravallion, and Dominque van de Walle. 2012. “Does India’s Employment Guarantee Scheme Guarantee Employment?” Economic and Political Weekly 48(21): 55-64. Dutta, Puja, Rinku Murgai, Martin Ravallion, and Dominque van de Walle. 2014. Right to Work? Assessing India’s Employment Guarantee Scheme in Bihar. World Bank, Washington DC. Himanshu. 2010. “Five Heady Years of MGNREGA.” Livemint website. August 31. Imbert, Clément. 2015. “MGNREGS, Labor Markets and Poverty.” Background paper prepared for the Social Protection Team, World Bank, New Delhi. Imbert, Clément and John Papp. 2013, “Labor Market Effects of Social Programs: Evidence from India’s Employment Guarantee,” Center for the Study of African Economies Working Paper Series 2013- 03, University of Oxford, Oxford, U.K. Muralidharan, Kartik, Paul Niehaus, and Sandip Sukhtankar. 2014. “Building State Capacity: Evidence from Biometric Smartcards in India.” NBER Working Paper 19999, Cambridge, MA. National Sample Survey Organization (NSSO). 2011. “Survey of MGNREGA 2010-11”. Ministry of Statistics and Programme Implementation. India. Zimmerman, Laura. 2013. “Why Guarantee Employment? Evidence from a Large Indian Public Works Program.” Mimeo, University of Michigan. April 2015 THE WORLD BANK 48 Towards a higher growth path India Development Update ANNEX: REFORM MEASURES The government announced several reform measures throughout the year, complimenting them with further measures in the annual budget. These spanned a vast spectrum of policy space including the labor market reforms, easing the business environment, fiscal prudence and improving the efficiency of transfer benefits and the quality of spending. If implemented fully they could unleash private investment, both domestic and FDI, in various sectors; make social spending more efficient, and help shift the orientation of public spending to capital expenditure. For these reforms to bear maximum mileage, these ought to be implemented in earnest, and accompanied by complimentary reforms by the states. They need to be extended to explore innovative ways to raise long term financing, as well as make the banking sector, especially the PSBs healthier and more efficient. A summary of these reform measures is provided below. 37 Monetary Policy x The government and the RBI signed the monetary policy framework, referred to as the “flexible inflation target” framework, wherein they agreed to a Target to bring CPI inflation below 6 percent by January 2016 and to 4 percent within a band of (+/-) 2 percent around it, by the end of 2016-17 and subsequent years thereafter. The objective was described to “primarily maintain price stability while keeping in mind the objective of growth”. x The agreement described as putting the RBI in charge of determining the policy rate or any other monetary measures to achieve the target; and to have the freedom to decide on, and to publish, the operating target and the operating procedure of monetary policy. x It would also be required to bring out a document every six months explaining the sources of inflation and a forecast for inflation for the following 6-18 months. x It further described that the central bank would be deemed to have missed its target if inflation exceeds more than 6.0 percent for three straight quarters in 2015-16 and all subsequent years; or if inflation is below 2.0 percent for three straight quarters in 2016-17 and all subsequent years. If the RBI is thus deemed to have failed to meet the Target, it would have to send a report to the government citing the reasons behind “the failure to achieve the target”, propose remedial actions to be taken by the RBI; and provide an estimate of the time period within which the target would be achieved after implementing the proposed remedial actions. Financial sector reforms The government and the central bank worked in tandem to initiate several financial sector reforms. These reforms when fully implemented are likely to have far reaching implications for growth, on improving the efficiency of social spending, help the poor smooth consumption and to be able to save and invest more prudently. They are also likely to improve the transmission of monetary policy. x Thrust on greater financial inclusion under the Pradhan Mantri Jan Dhan Yojana (PMJDY), under which over 125 million new accounts were opened until end January 2015. The account provides for debit card facility, an overdraft facility (for accounts which are Aadhaar linked), and accidental insurance coverage. x Public Sector Banks (PSBs) were allowed to reduce the government’s shareholding to 52 percent in a phased manner, to help with recapitalization. Important discussion were initiated to improve the functional autonomy of the PSBs, and to improve their governance structure, some of this discussion was modeled on the recommendation of the 37 The Fourteenth Finance Commission report was tabled during the budget session of the Parliament; we provide a summary of the recommendations made by the Finance Commission separately in Box 3. April 2015 THE WORLD BANK 49 Towards a higher growth path India Development Update PJ Nayak Committee report. x RBI awarded two new bank licenses; and laid out the norms for payment banks. x The Central Bank announced a revised regulatory framework with tighter norms for Non- Banking Financial Corporations (NBFCs), bringing it closer to the regulatory framework for commercial banks. Revisions include an increase in minimum capital requirement, tightened rules on deposits and bad loans and stricter corporate governance practices. x RBI released a framework for revitalizing distressed financial assets to incentivize early identification of problem cases; timely restructuring of accounts which are considered viable; prompt steps by banks for recovery of unviable accounts; higher rates on future borrowings by defaulters. x NBFCs with a size of INR 5 billion or more will be considered as ‘Financial Institutions’ in matters related to recovery. x The commodities market regulator, Forwards Market Commission, will be merged with the regulator of capital markets, Securities and Exchange Board of India to ensure a well regulated commodities market and reduction of wild speculation. x A new comprehensive law to deal with black money was introduced in the parliament. Under the proposed law, concealment of income and assets and evasion of tax in relation to foreign assets will be prosecutable. To curb domestic black money, a new Benami Transactions (Prohibition) Bill was introduced. x A Task Force will be created to establish sector-neutral Financial Redressal Agency (FRA) that will address grievances against all financial service providers. Trade and Capital Market x RBI relaxed gold import norms, reversing the quantitative restrictions imposed in 2013- 2014 to reduce gold imports. x Increased the limit on individual remittances to $250,000, from $125,000 (and $75,000 before that); restored the limit on Overseas Direct Investment by Corporates to 400 percent of net worth. x Allowed long-term foreign investors to reinvest their coupons in government bonds even if the limit of US$ 30 bn is utilized. x Merged different categories of foreign investors, under one head, Registered Foreign Portfolio Investor, in order to simplify the registration process. Allowed portfolio investment in government securities only in dated securities of residual maturity of one year and above; and mandated that all future investment by foreign portfolio investors in the debt market be for a minimum residual maturity of three years to encourage longer maturity flows. x A new Gold Monetization Scheme will be set up in replacement of the currently existing Gold Deposit and Gold Metal Loan Schemes, which would allow gold depositors to incur interest on their metal account, jewelers to obtain loans and banks and other dealers to monetize gold. x New gold deposits will be introduced to utilize 20,000 tonnes of available gold stock and sovereign bonds will be introduced as an alternative to purchasing metal. x Foreign investment will be allowed in Alternative Investment Funds (AIFs), a category of pooled-in investment vehicles for real estate, private equity and hedge funds. To ensure a smooth and integrated process of investment under such investments, the distinction between different categories of foreign investment such as Foreign Portfolio Investors (FPI) and Foreign Direct Investment (FDI) will be eliminated. x Proposed to amend, through the Finance Bill, Section-6 of FEMA to provide that control on capital flows as equity would be exercised by the Government (in consultation with the RBI). x A Public Debt Management Agency will be set up to help manage external and domestic debt. April 2015 THE WORLD BANK 50 Towards a higher growth path India Development Update Fiscal Fiscal reforms spanned the areas of taxes, expenditure, particularly subsidies. Taxes: x The pace of reforms to implement Goods and Services Tax (GST) gained momentum. A Constitutional Amendment Bill was introduced in the winter session of the parliament, and is widely expected to be implemented by April 2016. x The disinvestment Program picked up in December 2014, the government divested 10 percent of its share in Coal India Ltd. and 5 percent in SAIL. x Corporate tax is proposed to be reduced from 30 percent to 25 percent in a phased manner over the next four years. A phased rationalization and removal of various tax exemptions and incentives will be encouraged beginning next fiscal year to reduce tax disputes and improve administration. x A tax pass-through will be allowed under category I and II of alternative investments in order to mobilize resources. Additionally, rationalizing of capital gains regime and a pass- through for rental incomes of REITs was proposed. x Basic Customs duty on certain inputs, raw materials and intermediaries was reduced to minimize the impact of duty aversion. x Wealth tax will be replaced with a 2 percent surcharge on the super-rich with taxable income of over INR 10 million. x Educational cess will be subsumed by the Central Excise Duty and be increased to 12.4 percent. x Service charge plus educational cess will be raised to 14 percent. x Penalty provisions in indirect taxes will be rationalized to encourage compliance and early dispute resolution. Expenditure/social expenditure x The government continued to strive to expand the population that has been provided with a unique biometric based identification, under the Aadhaar program, targeting enrollment for 1 billion Indians. x In order to improve the efficiency of delivery of benefits under the Direct Benefits Transfer Scheme (DBTL), it was merged with the Pradhan Mantri Jan Dhan Yojana. The new simplified scheme does not mandate the need of an Adhaar card but simply, a new bank account under the PMJDY. x The Center commenced the Modified Direct Benefit Transfer Scheme for cooking gas (DBTL) in November. Under the scheme, consumers will receive direct cash subsidy to purchase cooking fuel at market prices; to be directly transferred to their bank accounts. The scheme covered 54 districts in its first phase, and was extended to another 246 districts from January 2015. x The current DBTL scheme enables cash benefit transfers to the beneficiaries of 35 schemes including cooking gas, the government announced the universalization of the DBT to all schemes and projects that have any component of cash benefits transfer to individual beneficiaries, from levels other than Central. x Setting up of National Employment Guarantee Fund under consideration under which MGNREGS account holders would directly receive wages in the accounts opened under the PMJDY scheme. x A panel set up in August, 2014 to restructure the Food Corporation of India, proposed measures to strengthen the distribution of food grains and, plug leakages and reduce the subsidy bill. These include giving the states which do not have provisions of administered purchase prices the responsibility of rice and wheat procurement, presenting direct cash subsidies of INR 3,000 to each beneficiary per year and outsourcing grain storage to private and government agencies. It also suggested a lower coverage of beneficiaries under the food law to 40 percent, down from 67 percent to cover more Below the Poverty Line (BPL) families. x The government instituted an Expenditure Management Commission to lay out a plan for April 2015 THE WORLD BANK 51 Towards a higher growth path India Development Update rationalizing expenditure. The terms of reference of the Commission included reviewing major areas of central government expenditure and suggest ways of creating fiscal space required to meet developmental expenditure needs without compromising the commitment to fiscal discipline. The interim report of the commission was to be submitted before the budget for 2015-16. x Authorities increased the Minimum Support Price by a modest 3.7 percent in 2014-15, and off-loaded food stocks. x Public capital expenditure, esp. on roads, railways and irrigation, expected to increase by 26 percent during 2015-16 (over last year) to 1.7 percent of GDP – in order to support the government vision on infrastructure strengthening. Some of the increase in capital spending to be tempered by further decline in petroleum subsides by 0.3 percent of GDP – on account of discontinuation of subsidies (diesel) on some products and containment of leakages on other (direct benefits transfers rolled out on LPG cylinders). x Universal social security and pension schemes were unveiled. These include: 1. Pradhan Mantri Bima Yojana- An accident insurance for all with an INR 2 lakh (INR 0.2 million) coverage and INR 12 per year premium. 2. Atal Pension Yojana- A defined pension to be received after the age of 60 and allocated according to contribution with 50 percent of the contribution to be made by the government for beneficiaries with open accounts before 2030. 3. Jiwan Bima Yojana- Insurance with an INR 2 lakh (INR 0.2 million) coverage and INR 330 per year premium with subsidized premiums for BPL card holders, small and marginal farmers and senior citizens. Energy x The Government deregulated diesel prices, paving the way for new investments in this sector. It raised gas prices from US$ 4.2 per million BTU to US$ 6.17 (a 33 percent increase), and linking pricing, transparently and automatically, to international prices so as to provide incentives for larger gas supply and thereby relieving the power sector bottlenecks; new “ultra-mega” solar power projects in four states and support to domestic solar panel/wind mill manufacturers. x Legal guidelines and procedures for allocation of coal mines were laid down. Following the Supreme Court judgment to cancel all but 4 coal mine allocations, the central government promulgated the Coal Mines (Special Provisions) Ordinance, 2014, laying down the procedure for auction of these cancelled coal blocks. The Coal Mines (Special Provision) Bill, 2015 was passed by the Parliament in March, replaced the ordinance. Infrastructure x Formation of the National Industrial Corridor Authority and a new institution (3PIndia) to support mainstreaming of PPPs; launch of tax-favorable Infrastructure Investment Trusts; development of 16 new ports, new inland waterways, and new airports in Tier-2 cities; funds for metros in Lucknow and Ahmedabad, and additional funds for railways in border areas. x An infrastructure investment fund worth INR 200 billion is proposed to be set up to create equity to finance infrastructure projects. Simultaneously, an INR 700 billion of additional investment will be allocated to infrastructure. x Tax-free bonds will be introduced to help raise equity for roadways, railways and irrigation projects. In similar vein, the PPP model is being revitalized to allow and encourage for greater private sector funding. x Corporatization of public sector ports and their conversion into companies under the Company’s Act will be encouraged to attract investments. x The introduction of a public Contracts Bill was proposed as a measure to streamline institutional arrangements for resolution of disputes. x Additionally, a proposal to introduce a regulatory reform bill was made in the Budget April 2015 THE WORLD BANK 52 Towards a higher growth path India Development Update which would bring about cogency of approach across all sectors of infrastructure. x 5 ‘Ultra mega’ power projects encompassing 4GW each are proposed to be set up in plug and play mode. Railways Budget The railway budget proposed to step up its capital expenditure and improve operational efficiency. It also lays out an ambitious plan for expansion in the next five years (INR 8.5 trillion or close to 6 percent of GDP) for expansion. For the current year it has proposed a 50 percent increase in plan expenditure, over the previous year, from 650 to INR 1 trillion in 2015-16; to be financed by a larger budgetary support, own savings, market borrowings as well as institutional investors. Labor and Land reforms x An ordinance to amend the Land Acquisition Act, 2014 was cleared by the President to make land acquisition easier in December, 2014. It eased the consent clause and impact assessment requirement for developmental projects related to industrial corridors, PPP projects, rural infrastructure, affordable housing and defense. A bill to regularize the ordinance was passed by Lok Sabha (lower house of the Parliament) on March 10, 2015 but is pending in the Rajya Sabha (upper house of the Parliament). x Presidential Assent for labor reforms in Rajasthan, setting an example for other States; consolidation of 16 laws to allow single online return; the inspection process made transparent. Ease of Doing Business reforms Thrust on improving the business environment continued. x The Government launched the Make in India campaign in this pursuit to make India a manufacturing hub and accelerate the growth in the manufacturing sector of India, and increase its share in GDP to 25 percent. x A G2B single-window portal called eBiz with eleven government services such as Employer Registration and Commencement of Business to eliminate the need for procedures and use technology in an integrated manner. Other measures include abolishing requirement of a Certificate of Commencement before the start of operations and replacing it with a simple rule of informing the Registrar of Companies online, creation of a streamlined system which detail all existing procedures and eliminate a human interface to provide clearances within a month. All business and investment clearances on a single online portal with an integrated payment gateway; single window customs clearance. x Single window clearance for capital intensive steel, coal and power projects. x A comprehensive bankruptcy code was proposed to be introduced in 2015-16, in line with international standards in order to enhance legal certainty. x An expert committee will be appointed to examine the possibility of and prepare a draft legislation to replace the need of multiple permissions with a pre-existing regulatory mechanism to expedite the process of permission acquisition. x The implementation of the General Anti-Avoidance Rules will be deferred by two years, delaying it to beginning of 2017-18. It brings ease to foreign investors who route foreign portfolios through tax havens in a bid to avoid taxes. x A National Skills Mission will be launched and will consolidate skill initiatives and standardize procedures. x The budget proposes to create a micro units development refinance agency, Mudra Bank, with a corpus of INR 200 billion and credit guarantee corpus of INR 30 billion in order to provide credit facilities to entrepreneurs with lending priority to SC/ST enterprises. The refinancing of institutions under The Mudra Bank will take place through the Pradhan Mantri Mudra Yojana. According to the Finance Minister currently out of the 57.7 million small business units, 62 percent are owned by SCs, STs and OBCs and The Mudra Bank will facilitate smoother funding for them. April 2015 THE WORLD BANK 53 Towards a higher growth path India Development Update x Setting up of a Self-Employment and Talent Acquisition (SETU) mechanism, a techno- financial, incubation and facilitation program to support start up business, particularly in technology-driven areas. A fund of INR 10 billion is being created under the NITI Aayog for the same. Foreign Direct Investment FDI cap increased in defense to 49 percent; 100 percent FDI in railway infrastructure; increase in FDI limit to 49 percent from 26 percent (issued as an ordinance). The procedural requirements were eased in 12 sectors, including- telecom, commodities exchange, insurance and petroleum. April 2015 THE WORLD BANK 54 Towards a higher growth path India Development Update APPENDIX: INDIA ECONOMIC OUTLOOK IN A CROSS COUNTRY PERSPECTIVE Below we compare India’s economic outlook and indicators of macroeconomic strengths and weaknesses with other large emerging markets in 2014. The set of emerging markets include Brazil, China, Indonesia, Malaysia, Mexico, Russia, South Africa, South Korea, Thailand, Turkey, The data is from Haver, unless otherwise indicated, downloaded on March 15, 2015. Appendix Figure 1: India is a large economy and… Appendix Figure 2: …One of the fastest growing economy Size of the Economies Real GDP Growth 2014 2014 10000 8 7 8000 % Change y-o-y 6 6000 5 Bil.US$ 4 4000 3 2000 2 1 0 0 Korea Turkey Brazil Thailand Malaysia India Russia Indonesia Mexico China South Africa Korea Malaysia India Brazil Turkey Russia Thailand China Mexico Indonesia South Africa Appendix Figure 3: Its Macroeconomic Outlook has Appendix Figure 4: …and current account deficit improved-- Inflation has declined, Fiscal deficit has has declined, foreign direct and portfolio investment declined, and growth has accelerated…. has increased, and accumulation of external reserves has increased 3 Difference in Difference in 2014 and 2013 2014-15 and 2013-14 50 2 40 30 1 Billion US$ 20 0 10 % 0 -1 -10 -2 -20 -30 Reserves FDI Portfolio Flows -3 Current Account -4 Inflation Fiscal Deficit % of Growth GDP Note: Figure 2, data for 2015 for Turkey, China and Brazil from consensus forecast; calendar years. Figure 3, data for India is from the Reserve Bank of India and the Ministry of Finance. Inflation data for India is for first three quarters of 2014-15; Growth is the estimate for 2014-15 from the CSO. Figure 4 refers to data for calendar year. April 2015 THE WORLD BANK 55 Towards a higher growth path India Development Update However for some of the macro indicators, India’s outlook is mixed when compared with other large emerging markets Appendix Figure 5: Inflation is still on the higher Appendix Figure 6: ….as is the fiscal deficit side…. CPI Inflation Fiscal Balance 2014 2014 10 0 9 -1 % Change y-o-y 8 -1 7 -2 % of GDP 6 -2 5 -3 4 -3 3 -4 2 -4 1 -5 0 -5 Korea Brazil Turkey Thailand China India Russia Malaysia Mexico Indonesia South Africa India Brazil Turkey Thailand China Russia Mexico Indonesia South Africa Appendix Figure 7: Share of manufacturing in GDP Appendix Figure 8: …and has been growing at a is low… modest rate Manufacturing ,Value Added 2013 Manufacturing ,Value Added Real Growth, 2013 35 8 30 % Change y-o-y 25 % of GDP 20 4 15 10 0 5 0 -4 Brazil Turkey Russia Mexico India Indonesia Malaysia Korea China Thailand South Africa Brazil Korea Malaysia Turkey Thailand India Mexico Indonesia South Africa April 2015 THE WORLD BANK 56 Towards a higher growth path India Development Update Appendix Figure 9: Exports growth (merchandise) Appendix Figure 10: ….and its share in World has been slow… Exports is low Merchandise Export Growth Merchandise Export 2014 % of World Merchandise Export 2013 6 14 4 12 % Change y-o-y 2 10 0 8 -2 6 -4 4 -6 2 -8 0 Turkey Brazil Thailand Russia Indonesia Malaysia India Mexico Korea China South Africa Brazil Korea Turkey Russia Thailand Indonesia India Malaysia Mexico China South Africa Appendix Figure 11: Credit to GDP ratio has been Appendix Figure 12: ….and has been growing slowly low… Private Sector Credit Private Sector Real Credit Growth 2014 2014 180 16 160 % Change y-o-y 140 12 120 % of GDP 100 8 80 60 40 4 20 0 0 Brazil Korea Turkey Thailand India Russia China South Africa Mexico Malaysia Indonesia Brazil India Turkey Malaysia Korea Mexico Indonesia Russia Thailand China South Africa Appendix Figure 13: Rate of Investment is Appendix Figure 14: ….but has been growing slowly comparable…. Gross Fixed Capital Formation Invetment Real Growth 2013 2013 50 10 45 8 40 % Change y-o-y 35 6 % of GDP 30 4 25 20 2 15 0 10 5 -2 0 -4 Brazil Malaysia India Korea Turkey Russia Thailand Mexico Indonesia China Korea Turkey Brazil South Africa Thailand Mexico India Russia Indonesia Malaysia China South Africa April 2015 THE WORLD BANK 57 Towards a higher growth path India Development Update Appendix Table 1: Selected Economic Indicators Average 2006- 2010 2011/12 2012/13 2013/14 2014/15 2015/16 2016/17 2017/18 Proj. Proj. Proj. Proj. Real Income and Prices (% change) GDP, market prices 8.3 6.6 5.1 6.9 7.2 7.5 7.9 8.0 Private Consumption 8.2 9.3 5.5 6.2 6.1 7.4 8.5 8.9 Government Consumption 8.7 6.9 1.7 8.2 8.6 8.7 8 7.5 Gross Fixed Investment 10.4 12.3 -0.3 3.0 4 9.0 12.0 13.0 Exports, GNFS 11.2 15.6 6.7 7.3 0.5 6.3 7.5 7.5 Imports, GNFS 13.6 21.1 6.0 -8.4 -0.4 9.1 13.0 15.0 GDP, factor cost 8.6 6.7 4.9 6.6 7.1 7.5 7.9 8.1 Agriculture 3.9 5.0 1.7 3.8 1.2 2.1 2.8 2.8 Industry 8.6 7.8 2.3 4.4 5.0 5.5 6.1 6.4 Services 10.1 6.6 8.0 9.1 10.6 10.5 10.5 10.5 GDP Deflator, market prices 7.2 8.5 7.6 6.2 5.9 6.1 5.2 4.9 Consumption, Investment and Savings (% of GDP) Consumption 68.1 68.8 69.8 71.0 71.9 72.5 73.5 74.2 Investment 1/ 31.8 33.6 31.4 29.7 28.8 29.2 30.6 32.0 Gross Savings 34.2 33.9 31.8 30.6 .. .. .. .. External Sector Current Account Balance (% of GDP) -2.0 -4.3 -4.8 -1.7 -0.7 -0.9 -1.7 -2.7 General Government Finances (% of GDP) Deficit 2/ 6.9 -7.8 -7.2 -6.8 -6.7 -6.1 -5.6 -4.7 Total Debt 71.3 68.3 67.7 66.8 64.8 62.7 60.7 58.5 Note: All figures in Italics are based on the old GDP series (2004-05 base) 1/ Gross fixed capital formation 2/ Inclusive of receipts from 3G spectrum auctions and disinvestment Sources: Central Statistical Office, Reserve Bank of India, and World Bank Staff Estimates. April 2015 THE WORLD BANK 58 Towards a higher growth path India Development Update Appendix Table 2: Central Government Finances Average 2014-15 2014-15 2015-16 (percent of GDP) 2006-2010 2011-12 2012-13 2013-14 (BE) (RE) (BE) Total Revenue and Grants 10.2 8.7 9.1 9.2 9.7 9.1 8.6 Net Tax Revenue 7.8 7.1 7.4 7.2 7.6 7.2 6.5 Gross Tax Revenue 10.7 10.1 10.4 10.0 10.6 9.9 10.3 Corporate Tax 3.7 3.7 3.6 3.5 3.5 3.4 3.3 Taxes on Income 1.9 1.9 2.0 2.1 2.2 2.2 2.3 Excise Tax 2.1 1.6 1.8 1.5 1.6 1.5 1.6 Service Tax 1.0 1.1 1.3 1.4 1.7 1.3 1.5 Customs Duties 1.8 1.7 1.7 1.5 1.6 1.5 1.5 Less: States' share 2.8 2.9 2.9 2.8 3.0 2.7 3.7 Non Tax Revenue 1/ 2.1 1.4 1.4 1.8 1.6 1.7 1.6 Non-Debt Capital Receipts 0.3 0.2 0.3 0.3 0.5 0.2 0.5 Total Expenditure and Net Lending 14.8 14.6 14.0 13.6 13.8 13.2 12.5 Current Expenditure 13.1 13.0 12.4 12.1 12.2 11.8 10.9 Interest Payments 3.3 3.1 3.1 3.3 3.3 3.3 3.2 Subsidies 1.9 2.5 2.6 2.2 2.0 2.1 1.7 o/w Petroleum 0.2 0.8 1.0 0.8 0.5 0.5 0.2 Capital Expenditure and Net Lending 1.7 1.6 1.5 1.5 1.7 1.4 1.6 Recovery of loans 0.1 0.2 0.2 0.1 0.1 0.1 0.1 Capital Spending 1.9 1.8 1.7 1.7 1.8 1.5 1.7 Gross Fiscal Deficit (GoI defn) 4.6 5.8 4.9 4.4 4.1 4.1 3.9 Memo items Disinvestment 0.3 0.2 0.3 0.3 0.5 0.2 0.5 Gross Fiscal Deficit (WB defn) 5.2 6.0 5.2 4.7 4.6 4.3 4.4 Primary Deficit (GoI defn) 1.3 2.7 1.8 1.1 0.8 0.8 0.7 Primary Deficit (WB defn) 1.9 3.0 2.0 1.4 1.3 1.0 1.2 Central Government Debt (incl external debt) 2/ 54.8 46.1 46.1 46.0 45.4 46.8 46.1 Source: Ministry of Finance Note: 1/ Includes revenues from spectrum auctions 2/ Does not include part of NSSF and MSS liabilities not used for financing Central government debt All figures in Italics are based on the old GDP series (2004-05 base) April 2015 THE WORLD BANK 59 Towards a higher growth path India Development Update Appendix Table 3: Development Indicators Indicator 2000 2005 2010 2011 2012 Demographics Population (millions) 1042.3 1127.1 1205.6 1221.2 1236.7 Poverty and Income Distribution Poverty $1.25/day PPP, headcount ratio percent .. 41.6 32.7 .. 23.6 Poverty $2/day PPP, headcount ratio percent .. 75.6 68.8 .. 59.2 National Poverty Estimates, headcount ratio percent .. 37.2 29.8 .. 21.9 Gini Coefficient .. 33.4 33.9 .. 33.6 Labor Labor force participation rate, total 58.6 60.4 54.8 .. 53.4 Labor force participation rate, female 34.1 37.3 29.0 .. 27.2 Labor force participation rate, male 82.3 82.9 79.7 .. 78.8 Unemployment, total 4.3 4.4 3.5 .. 3.6 Health Infant Mortality Rate (per '000 live births) 68.0 58.0 47.0 44.0 42.0 Education Lower Secondary gross enrolment rate (%) 52.2 65.2 66.6 .. Senior Secondary gross enrolment rate (%) 28.5 39.4 45.9 .. Tertiary gross enrolment rate (%) .. 19.4 20.8 21.1 Sources: WDI, CEIC, and World Bank staff estimates. The table reflects closest data available for stated years. Poverty rates are for the 2004-05, 2009-10 and 2011-12 periods. April 2015 THE WORLD BANK 60 Macroeconomics & Fiscal Management