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Economic Survey 2014-15 - Volume I
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....conomic Survey 2014-15 - Volume I <br>News and Press Release<br>Dated:- 27-2-2015<br><BR>============= Document 1सतà¥à¤¯à¤®à¥‡à¤µ जयते Economic Survey 2014-15 Volume I Government of India Ministry of Finance Department of Economic Affairs Economic Division February, 2015 CONTENTS The Growth-Fiscal Policy Challenge 1 1 1 3 12 Economic Outlook, Prospects, and Policy Challenges Introduction Macroeconomic Review and Outlook Inflation and Money 15 External Sector 18 Agriculture 19 21 25 28 32 34 37 38 41 2 45 +44748 22858 49 50 3 52 52 53 57 63 64 64 66 66 67 68 10 2212222 75 'Wiping Every Tear From Every Eye': The JAM Number Trinity Solution Growth Private and Public Investment The Banking Challenge Manufacturing, Services and the Challenges of "Making in India" The Trade Challenge Climate Change Empowering Women: Unleashing Nari Shakti Cooperative Federalism and the Recommendations of the Fourteenth Finance Commission (FFC) Fiscal Framework Introduction and Summary Background and History Lessons Medium-Term Strategy Short-Term Issues Conclusions 'Wiping Every Tear From Every Eye': The JAM Number Trinity Solution Introduction Subsidising ....
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....Whom? The Case of Kerosene The Case of Food The Possibilities Offered by Cash Transfers The JAM Number Trinity Solution The Investment Climate: Stalled Projects, Debt Overhang and The Equity Puzzle Introduction Rate of Stalling and Stock of Stalled Projects An Analysis of Stalled Projects Balance Sheet Syndrome With Indian Characteristics What is Impact of Balance Sheet Syndrome on Firm Equity? Policy Lessons 77 Credit, Structure and Double Financial Repression: A Diagnosis of the Banking 5 77 Sector Introduction 78 Financial Repression on the Liability Side Financial Repression on the Assets Side 79 81 85 88 BRRY A Comparative Analysis of Banking and Credit Are Public Sector Banks Uniform in performance? Policy Implications (i) 6 89 89 89 ཆེཆེ ི བ ཅ 91 101 7 102 102 103 105 111 114 8 117 117 Putting Public Investment on Track: The Rail Route to Higher Growth Introduction Effects of Increasing Public Investment on Overall Output and Private investment The Case for Public Investment in Railways Policy Recommendations-Key Takeaways What to Make in India? Manufacturing or Services? Introduction Desirable features of Sectors that can Serve as Engi....
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....nes of Structural Transformation The Manufacturing Scorecard The Service Scorecard Summary Scorecards and Conclusions A National Market for Agricultural Commodities- Some Issues and Way Forward Introduction APMCs Levy Multiple Fees, of Substantial Magnitude, that are Non-transparent, and hence a Source of Political Power Essential Commodity act, 1955 vs APMC Act 117 118 119 Model APMC Act 120 Karnataka Model 120 120 Inadequacies of Model APMC Act Alternative ways of Creating National Market for Agricultural Commodities 121 Using Constitutional Provisions to Set up Common market 9 122 122 From Carbon Subsidy to Carbon Tax: India's Green Actions Introduction 123 Excise Duty on Petrol and Diesel as an Implicit Carbon Tax 125 125 125 128 10 129 129 Introduction 129 131 134 137 How Does India Compare with Other Countries? CO2 Emission Reductions From Petrol and Diesel Taxes and Coal Cess Translating Coal Cess into Carbon Tax Conclusions and Key messages The Fourteenth Finance Commission (FFC) - Implications for Fiscal Federalism in India? Major Recommendations of FFC Implications of FFC Recommendations for Fiscal Federalism: A way Ahead Balancing Fiscal Autonomy and Fiscal Space Caveats....
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.... and Conclusion (ii) NOTES The following figures/units are used in the Economic Survey: BCM billion cubic metres BU billion units MT million tonnes lakh 1,00,000 million 10 lakh crore 10 million kg kilogram ha hectare Bbl billion barrels per litre billion trillion 1,000 million/100 crore 1,000 billion/100,000 crore Acknowledgements The Economic Survey is a result of teamwork and collaboration. I was assisted in the coordination tasks by Anandi Subramanian and N.K. Sinha. Contributors to the Survey from the Economic Division include: H.A.C Prasad, D.S. Kolamkar, Ila Patnaik, Anandi Subramanian, K.L Prasad, A.S. Sachdeva, Rajat Sachhar, Rajasree Ray, Antony Cyriac, R. Sathish, P. K. Abdul Kareem, N. K. Sinha, Priya Nair, Rajmal, J.K. Rathee, K.M. Mishra, Rangeet Ghosh, Abhishek Acharya, Kapil Patidar, Syed Zubair Husain Noqvi, Neha Yadav, Aakanksha Arora, Rabi Ranjan, Deepak Kumar Das, Vijay Kumar, M. Rahul, Rohit Lamba, Siddharth Eapen George, Sutirtha Roy, V.K. Mann, Riyaz A. Khan, Shobeendra Akkayi, Salam Shyamsunder Singh, Md. Aftab Alam, Sanjay Kumar Das, Subhash Chand, Praveen Jain, Narendra Jena, Pradyut Kumar Pyne, Jyotsna Mehta, Kanika Grover and Rajesh. The survey has great....
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....ly benefited from the comments and inputs of officials, specifically, Rajiv Mehrishi, Saurabh Chandra, Sudhir Kumar, Arbind Modi, K.P.Krishnan, UKS Chauhan and Arunish Chawla; and a number of external collaborators, including Anant Swarup, Apoorva Gupta, Bimal Jalan, Devesh Kapur, Fan Zhang, Harsha Vardhana Singh, Jean Dreze, Josh Felman, Karthik Muralidaran, Krishnamurthy Subramanian, Manish Sabharwal, Mohit Desai, Muthukumar Mani, Namita Mehrotra, Nandan Nilekani, Nick Stern, Nisha Agrawal, P.S Srinivas, Partha Mukhopadhyay, Pranjul Bhandari, Pratap Bhanu Mehta, Raghuram G. Rajan, Rajiv Lall, Rakesh Mohan, Reetika Khera, Richard Bullock, Rohini Malkani, Sajjid Chinoy, Sandip Sukhtankar, Sonal Verma, T.V.Somanathan Tushar Poddar and Vijay Kelkar. Apart from the above, various ministries, departments, and organisations of the Government of India made contributions on their respective sectors. Able administrative support was given by Agam Aggarwal, Sadhna Sharma, Suresh Arora, Amit, Rajat Verma and staff members of the Economic Division. Amarnath and his team of translators carried out the Hindi translation, while Shalini Shekhar adeptly edited the document. The Government of India ....
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....Press, Minto Road and Mayapuri undertook the printing of the English and Hindi versions of the survey. (iii) Arvind Subramanian Chief Economic Adviser Ministry of Finance Government of India PREFACE The Economic Survey is a collective effort, of numerous contributors in government and outside, as well as analysts abroad, but above all, of the dedicated staff of the Economic Division of the Department of Economic Affairs. To all of them is owed gratitude and thanks for hard work done, and done well and cheerily, meeting stiff deadlines and contending with the vicissitudes of rules and personalities. All Economic Surveys bear the imprint of the incumbent Chief Economic Adviser. And so it is with this one. But the desire for change must be balanced by the imperative of maintaining continuity, in order to be respectful of, and gain from, traditions that have survived the tests of time, whim, fashion, and politics. Inspired by the IMF's World Economic Outlook, this Survey departs structurally from its predecessors and presents its output in two volumes. Volume 1 discusses the outlook and prospects as well as a number of analytical chapters addressing topical policy concerns. Volume 2 de....
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....scribes recent developments in all the major sectors of the economy and contains all the statistical tables and data. In a sense, Volume 1 is forward-looking but gaining from the perspective provided by the recent past which is the subject of Volume 2. In deciding the content of Volume 1 of the Survey, one challenge was to reconcile the vaguer claims of posterity and the clearer demands of the pressing present. Another related challenge was the hardy perennial: depth or breadth? John Maynard Keynes famously said that it is necessary to distinguish the important from the urgent. At this juncture, with a new government in power and about to present its first full budget, and given the constraints of time and resources, this Survey has taken Keynes' advice to heart. The Survey favours the present, erring on the side of being expansive in scope even if the consequence has been to privilege cursory examination over in-depth analysis. The broad themes of the Survey are “creating opportunity and reducing vulnerability." Growth is the prerequisite for achieving many economic and indeed other objectives. Maximizing the benefits of growth will, of course, require complementary public a....
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....ctions, but without growth, possibilities across the income spectrum shrink. Increasingly, the debate on reducing poverty and vulnerability more generally is less about "whether†and more about "how best" direct government support can complement broader economic growth. Growth versus distribution is, as it always should have been, a false choice. Volume one begins with a chapter on the macroeconomic outlook and prospects for the Indian economy which sets the context for brief discussions of the policy issues focused on “creating opportunity and reducing vulnerability." These issues are then elaborated in the following nine chapters. Growth requires macroeconomic and hence fiscal stability (Chapter 2). A re-visiting of the fiscal framework is also necessary because this is the first full budget of the government and because of the reported recommendations of the Fourteenth Finance Commission that could decisively shape center-state fiscal relations. This is followed by a chapter on "wiping every tear from every eye" where the focus is on how support is best provided and the role that technology can play in this regard. The following chapters cover the state of stalled pr....
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....ojects and their implications for private and public investment going forward (Chapter 4); a brief diagnosis of the banking system and its implications for reforming it (Chapter 5); and the role of railways in driving future Indian growth (Chapter 6). There is a more academic discussion that speaks to the Make in India initiative, shedding light on the debate between manufacturing and services and suggesting alternative ways of thinking about transformational sectors (Chapter 7). Completing the discussion of sectors is a chapter on creating a single market in agriculture from what are in effect thousands of markets (Chapter 8). Climate change is increasingly central to economic development and creates challenges. These are discussed in Chapter 9. Chapter 10 deals with what is a dramatic re-shaping of Centre-State fiscal relations. It provides a preliminary analysis of the implications of the recommendations of the Fourteenth Finance Commission. For the attention deficit-challenged, the outlook could be the port of only call, while others may find the detailed chapters of additional interest. Within Volume 1, there is some repetition, although that is inherent to having to cater to ....
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....multiple audiences. The Survey places a premium on new ideas or new perspectives both of an academic and policy nature. The limitations of time and resources mean that new ideas may not pass the most rigorous standards of the academy. But the approach is to find new data or present old data in a new form, to make connections, and to draw insights wherever possible, all with the aim of shedding light on policy. The aim is to provoke and stimulate debate and discussion, thereby enriching the process of policy-making, and hopefully, improving its outcome. The survey also aims to be readable, rising to the challenge of making dry economics as accessible as an op-ed (or perhaps a blog) without fully sacrificing the rigor of a more serious tome. The discipline may be dismal but, dear reader, it should not be dreary. Arvind Subramanian Chief Economic Adviser Ministry of Finance, GOI (iv) ABBREVIATIONS \GDP GST Gross Domestic Product Goods & Services Tax OPEC TOT CPI GTR Gross Tax Revenue RBI CSO Consumer Price Index Reserve Bank Of India Central Statistics Office WPI CMIE ICR PPP MOSPI Ministry of Statistics and Program NDA National Democratic Alliance Implementation SLR MGNREGA Mahatma G....
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....andhi National Rural Employment Guarantee Act PSL ROA FRBM CST JAM Fiscal Responsibility & Budget Management Act Central Sales Tax SARFESI ASER LPG BPL AAT APL PDS Ꭰá´áŽ¢ MSP NSSO IFSC Jan Dhan Yojana - Aadhar - Mobile Annual Survey of Education Report Liquified Petroleum Gas Below Poverty Line Antodaya Anna Yojana Above Poverty Line Public Distribution System Direct Benefit Transfer Minimum Support Price National Sample Survey Office Indian Financial System Code SMES SEZ CVD SAD ICAR WTO FTA TPP Organization of Petroleum Exporting Countries Terms of Trade Wholesale Centre for Monitoring the Indian Economy Interest-Coverage Ratio Public Private Partnership Statutory Liquidity Ratio Prioroty Sector Lending Return on Assets The Securetization and Reconstruction of Financial Assets and the Enforcement of Security Interest Small & Medium Enterprises Special Economic Zone Countervailing Duties Special Additional Duties Indian Council of Agricultural Research World Trade Organization Free Trade Agreement Trans-Pacific Partnership TTIP Trans-Atlantic Trade and Investment UNDP United Nations Development Program RCEP UNIDO United Nations Industrial Development Organisation ASEAN....
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.... UNFCCC WDI World Development Indicator GGDC APMC Groningen Growth and Development Centre Agricultural Produce Market Committee IPCC HDI VAT Value Added Tax GII FDI Foreign Direct Investment NFHS MOP&NG Ministry of Petroleum and Natural Gas ELA GHG Green House Gas VECM GIZ German Agency for International Cooperation VAR PMGSY Pradhan Mantri Gram Sadak Yojana PPP NTKM Net Tonnes Per Kilometre DFC Partnership Regional Comprehensive Economic Partnership Association of South-East Asian Nations United Nations Framework Convention on Climate Change Inter-governmental Panel on Climate Change Human Development Index Gender Inequality Index National Family Health Survey Expected Levels of Achievement Vector Error Correction Model Vector Auto-Regression Purchasing Power Parity Dedicated Freight Corridor PKM Passenger Kilometre CAPEX Capital Expenditure RIRI Rational Investor Rating Index BSE Bombay Stock Exchange BRIC Brazil Russia India China EBIT CPI (IW) Consumer Price Index (Industrial Workers) NHAI MMDR Mines & Minerals (Development and UMPP Ultra Mega Power Projects Regulation) LPVR LB Labour Bureau ISB EC Economic Census ANBC ASI Annual Survey of Industries NPA IMF US EIA Internationa....
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....l Monetary Fund US Energy Information Administration CRAR PSB Earnings before Interest & Tax National Highway Authority of India Least Present Value of Revenue Indian School of Business Adjusted Net Bank Credit Non-Performing Asset Capital to Risk-Weighted Assets Ratio Public Sector Banks (v) Economic Outlook, Prospects, and Policy Challenges 01 CHAPTER 1.1 INTRODUCTION A political mandate for reform and a benign external environment have created a historic moment of opportunity to propel India onto a double-digit growth trajectory. Decisive shifts in policies controlled by the Centre combined with a persistent, encompassing, and creative incrementalism in other areas could cumulate to Big Bang reforms. As the new government presents its first full-year budget, a momentous opportunity awaits. India has reached a sweet spot―rare in the history of nations—in which it could finally be launched on a double-digit medium-term growth trajectory. This trajectory would allow the country to attain the fundamental objectives of "wiping every tear from every eye" of the still poor and vulnerable, while affording the opportunities for increasingly young, middle-class, and aspirati....
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....onal India to realize its limitless potential. 1 This opening has arisen because facts and fortune have aligned in India's favour. The macro-economy has been rendered more stable, reforms have been launched, the deceleration in growth has ended and the economy appears now to be recovering, the external environment is benign, and challenges in other major economies have made India the near-cynosure of eager investors. Daunting challenges endure, which this Survey will not ignore, but the strong political mandate for economic change has imbued optimism that they can be overcome. India, in short, seems poised for propulsion. Any Economic Survey has to grapple with prioritization, to navigate the competing pitfalls of being indiscriminatorily inclusive and contentiously selective. Accordingly, this Survey will focus on the two broad themes-creating opportunity and reducing vulnerability—because they are the two pressing themes of the day and which between them encompass the many key policy challenges that the new government must address. The outline for this volume of the Economic Survey is as follows. A brief macroeconomic review and outlook will set the context for the broader....
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.... thematic and policy discussions that follow. The importance of economic growth, both for lifting up those at the bottom of the income and wealth distribution, and providing opportunities for everyone in that distribution, cannot be overstated.' Rapid, sustainable, and all-encompassing growth requires a strong macroeconomic foundation, key to which is fiscal discipline and a credible medium term fiscal framework. These prerequisites are discussed in Sections 1.2 and 1.6. But "wiping every tear from every eye" also requires proactive support from the government in the form of a well-functioning, well-targeted, leakage-proof safety net that will both provide (minimum income) and protect (against adverse shocks). This is also true in rural India where economic conditions for farmers and labourers are under stress. The policy issue now is no longer whether but how best to "provide and protect," and technology-based direct benefit transfers will play an important role in this regard (discussed in Section 1.7. Bhagwati, J. and Arvind Panagariya, "Why Growth Matters: How Economic Growth in India Reduced Poverty and the Lessons for Other Developing Countries", 2013, A Council on Foreign Re....
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....lations Book, Public Affairs Books. 2 Economic Survey 2014-15 Perspiration and inspiration, investment and efficiency, respectively, determine long-run growth. But the Indian private investment climate is clouded by the experience of the last decade. A combination of factors-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. Private investment must remain the main engine of long-run growth. But, in the short to medium term, as the near-intractable problems get slowly resolved, public investment, especially by the railways, will have to play a catalytic role. These issues and how the banking system can play a supportive role are the focus of discussions in sections 1.8 and 1.9.2 Manufacturing and trade have been the engines of growth in the post-war period for most economies, especially in Asia. The validity of that experience for India, which acquires salience in the context of the 'Make in India' initiative, is the focus of section 1.10. The following section then takes up challenges related to trade. Sections 1.12 an....
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....d 1.13—on climate change and gender equality respectively-deal with issues which India cannot and must not ignore. These are central to the challenges of growth, development and equality of opportunity. The objective of protecting the vulnerable must specifically take account of the fact that while India is increasingly young, middle-class, and aspirational, it is still persistently stubbornly male. All these policy issues and challenges are elaborated in Chapters 2-10 in this volume. The last section deals with what is a dramatic re-shaping of Centre-State fiscal relations. It provides a preliminary analysis of the key implications of the recommendations of the Fourteenth Finance Commission. Given the expectations surrounding the upcoming budget, one question needs to be addressed head- on: Does India need Big Bang reforms? Much of the cross-country evidence of the post-war years suggests that Big Bang reforms occur during or in the aftermath of major crises. Moreover, Big Bang reforms in robust democracies with multiple actors and institutions with the power to do, undo, and block, are the exception rather than the rule. India today is not in crisis, and decision-making au....
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....thority is vibrantly and frustratingly diffuse. Not only are many of the levers of power vertically dispersed, reflected in the power of the states, policy-making has also become dispersed horizontally. The Supreme Court and the Comptroller and Auditor General have all exerted decisive influence over policy action and inaction. Moreover, some important reforms such as improvements to tax administration or easing the cost of doing business, require persistence and patience in their implementation, evoked in Max Weber's memorable phrase, “slow boring of hard boards". Hence, Big Bang reforms as conventionally understood are an unreasonable and infeasible standard for evaluating the government's reform actions. Equally though, the mandate received by the government affords a unique window of political opportunity which should not be foregone. India needs to follow what might be called "a persistent, encompassing, and creative incrementalism" but with bold steps in a few areas that signal a decisive departure from the past and that are aimed at addressing key problems such as ramping up investment, rationalizing subsidies, creating a competitive, predictable, and clean tax policy ....
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....environment, and accelerating disinvestment. Thus, Weber's wisdom cannot be a licence for inaction or procrastination. Boldness in areas where policy levers can be more easily pulled by the center combined with that incrementalism in other areas is a combination that can cumulate over time to Big Bang reforms. That is the appropriate standard against which future reforms must be assessed. 2 Financial sector issues were discussed extensively in last year's Survey. Economic Outlook, Prospects, and Policy Challenges 3 1.2. MACROECONOMIC REVIEW AND OUTLOOK Macroeconomic fundamentals have dramatically improved for the better, reflected in both temporal and cross-country comparisons. Start first with the changing macro-economic circumstances. The changing fortunes of India have been nothing short of dramatically positive (Figure 1.1). Inflation has declined by over 6 percentage points since late 2013, and the current account deficit has shrivelled from a peak of 6.7 percent of GDP (in Q3, 2012-13) to an estimated 1.0 percent in the coming fiscal year. Foreign portfolio flows (of US$ 38.4 billion since April 2014) have stabilized the rupee, exerting downward pressure on long-term interest....
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.... rates, reflected in the yield on 10-year government securities, and contributed to the surge in equity prices (31 percent since April in rupee terms, and even more in US dollars, ranking it the highest amongst emerging markets). In a nearly 12-quarter phase of deceleration, economic growth averaged 6.7 percent but since 2013-14 has been growing at 7.2 percent on average, the later based on the new growth estimates (see Box 1.1 on how to interpret them). As a result of these improvements, India's macroeconomic position now compares favourably with other countries. Figure 1.2 depicts an overall macro-vulnerability index (MVI) that combines a country's fiscal deficit, current account deficit, and inflation. The index is thus comparable across countries and across time. In 2012, India was the most vulnerable country as measured by its index value of 22.4, comprising an inflation rate of 10.2 percent, a budget deficit of 7.5 percent and a current account deficit of 4.7 percent of GDP, well above that in the other countries. Turkey in 2014 surpassed India because of high current account deficit (of nearly 8 percent). Today, India's fortunes have improved dramatically and India demonstra....
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....ted the greatest improvement in the MVI while many others maintained the status quo or showed only a marginal improvement or deteriorated dramatically (Russia). India is still more vulnerable than the mean of countries in its investor rating category (BBB) but is less so than many of its larger emerging market peers. If macro-economic stability is one key element in assessing a country's situation/potential, its growth- actual and prospective- is another. A simple way therefore to compare the relative economic situation is to supplement the macro-economic vulnerability index with a "Rational Investor Ratings Index (RIRI).â€Â³ In assessing the risks and rewards of competing destinations, rational investors take into account not just macroeconomic stability (which proxies for risks) but also growth which crucially determines rewards and returns. In figure 1.3 this index is depicted for India and a number of comparator countries, including the BRICS, other major emerging markets (Turkey) as well as countries in India's investor rating category (BBB) and category (A) that is above India's. Regardless of whether Indian growth is measured according to the old methodology or the ne....
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....w methodology (see Box 1.1), India exhibits a dramatic improvement in the index. India ranks amongst the most attractive investment destinations, well above other countries. It ranks well above the mean for its investment grade category, and also above the mean for the investment category above it (on the basis of the new growth estimates). Amongst BRICS (and other comparable countries) only China scores above India. The reality and prospect of high and rising growth, combined with macroeconomic stability, is the promise of India going forward. 3The RIRI is computed by averaging a country's GDP growth rate and its macro-economic indicators; the latter measured as the average of the fiscal deficit, current account deficit, and inflation (all with negative signs). Thus, equal weight is given to growth and macroeconomic stability. The greater the number, the better should be its investor rating. Since, updated WEO forecasts are not publicly available for all countries, data are from Citi Group and have been updated in January assuming an oil price in the range of US$ 58-60 per barrel for 2015. Data from other sources yield very similar estimates for the RIRI. 4000 1-Jan-13 5000 1-Feb-....
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....13 1-Mar-13 6000 7000 8000 0006 -5 -7 3 5 7 9 -9 2004-05:Q1 -1 3 7 5 0 12 10 8 6 4 2 4 Economic Survey 2014-15 Figure 1.1A: WPI and CPI Inflation, April 2013 to January 2015 (Per cent) 16 14 WPI headline CPI NS headline Figure 1.1B: Current Account Balance and Net Foreign Investment, 2004-05 Q1 to 2014-15Q2 (per cent of GDP) 2004-05:Q2 2004-05:Q3 2004-05:Q4 2005-06:Q1 2005-06:Q2 2005-06:Q3 2005-06:Q4 2006-07:Q1 2006-07:Q2 2006-07:Q3 2006-07:Q4 2007-08:Q1 2007-08:Q2 2007-08:Q3 2007-08:Q4 2008-09:Q1 2008-09:Q2 2008-09:Q3 2008-09:Q4 2009-10:Q1 Figure 1.1C: Daily Stock Prices (Nifty), January 2013 to February 2015 10000 1-Apr-13 1-May-13 1-Jun-13 1-Jul-13 1-Aug-13 1-Sep-13 1-Oct-13 1-Nov-13 1-Dec-13 1-Jan-14 1-Feb-14 1-Mar-14 1-Apr-14 1-May-14 1-Jun-14 1-Jul-14 1-Aug-14 1-Sep-14 1-Oct-14 1-Nov-14 1-Dec-14 1-Jan-15 1-Feb-15 Current Account Balance/GDP 0 6 8 10 12 2009-10:Q2 2009-10:Q3 2009-10:Q4 2010-11:Q1 2010-11:Q2 2010-11:Q3 ли 2010-11:Q4 2011-12:Q1 2011-12:Q2 CPI NS food & beverages 2011-12:Q3 2011-12:Q4 2012-13:Q1 2012-13:Q2 2012-13:Q3 2012-13:Q4 2013-14:Q1 2013-14:Q2 2013-14:Q3 2013-14:Q4 2014-15:Q1 2014-15:Q2 Net Foreign Investment/GDP Figure 1.1D: Quarterly GDP Growth, 200....
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....5-06Q1 to 2014-15Q4 (Per cent) Sources: Office of Economic Adviser, Department of Industrial Policy and Promotion, Central Statistics Office, Reserve Bank of India and National Stock Exchange Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 2005-06 2006-07 2007-08 2008-09 2009-10 2010-11 2011-12 2012-13 | 2013-14* | 2014-15*| *Quarterly data for 2013-14 and 2014-15 is from the New GDP series released by CSO with base year revised to 2011-12 Economic Outlook, Prospects, and Policy Challenges Figure 1.2: Maco-Vulnerability Index for Selected Emerging Market Countries, 2010 to 2015 24 20 16 12 8 4 5 0 2010 2011 2012 2013 2014 2015 Brazil Indonesia -South Africa Turkey India Russia Mean MVI (BBB) Figure 1.3: Rational Investor Ratings Index for Selected Emerging Market Countries, 2010 to 2015 5 4 3 2 1 0 -1 -2 -3 -4 2010 2011 2012 2013 2014 2015 ... Brazil Indonesia India (New GDP) China -Russia -- Mean (BBB Rating) India (Old GDP) --- Mean (A Rating) Source: MoF calculations. 1.2A. Macro-economic management and policy reforms attention. The cumulative impact of these reforms on reviving investment and growth could b....
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....e Reforms have been initiated in a number of significant. Equally important though has been areas and major ones are on the horizon. The macroeconomic response to the favourable terms of trade shock has led to an appropriately prudent mix of increased government savings and private consumption. The policy reforms of the new government—actual and prospective-have attracted worldwide macro-economic management which needs to be assessed in simple analytical terms. Since June 2014, India has experienced a very favourable terms-of-trade shock as a result of a 50-55 percent decline in the price of crude-oil and other commodities. The accepted injunction from the standard macroeconomic manual is that responses to terms-of-trade shocks should be 6 Economic Survey 2014-15 Box 1.1: Revised Estimates of GDP and GDP growth Notwithstanding the new estimates, the balance of evidence and caution counsel in favour of viewing India as a recovering rather than surging economy. On January 30, the Central Statistics Office released a new GDP series that entailed shifting the base year from 2004- 05 to 2011-12 but also using more data and deploying improved methodologies (Chapter 1 in the second....
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.... volume of the Survey provides greater details). New estimates for GDP have been provided for the years 2011-12 to 2014-15. How should one view these estimates? First, the improvement in data and methods puts India on par with international standards of GDP estimation. India is perhaps unique in that GDP revisions result in lower numbers rather than the typically high upward revision seen in many countries. The key estimate for the level of GDP for 2011-12, which is the new base year, is actually 2 percent lower than previously estimated. However, the growth estimates warrant further reflection. On the one hand, directionally the growth estimate for 2014-15 relative to that for 2013-14 seems plausible and consistent with the fact of improving investor sentiment and reform actions. On the other, both directionally and in level terms, the growth estimate for 2013-14 is puzzling. According to the new estimates, growth at market prices in 2013-14 apparently accelerated by 1.8 percentage points to 6.9 percent (1.5 percentage points for growth at basic prices). These numbers seem difficult to reconcile with other developments in the economy. 2013-14 was a crisis year— capital flow....
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....ed out, interest rates were tightened, there was consolidation and it is difficult to see how an economy's growth rate could accelerate so much in such circumstances. Also, imports of goods in 2013-14 apparently declined by 10 percent, which, even accounting for the squeeze on gold imports, is high. Growth booms are typically accompanied by import surges not import declines. This boom was one over-reliant on domestic demand because the contribution of net external demand was substantially negative. This growth surge also appears to have been accompanied by dramatic declines in savings and investment ratios. For example, gross fixed capital formation declined from 33.6 percent in 2011-12 to 29.7 percent in 2013-14 while gross domestic savings declined from 33.9 percent to 30.6 percent. The implication is that the growth surge in the crisis year of 2013-14 was also a massive productivity surge, reflected in an incremental capital ratio that declined by about 30 percent, and total factor productivity growth that improved by over 2 percentage points. The data show that private corporate investment increased robustly in 2013-14 which seems at odds with stressed balance sheets and the ph....
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....enomenon of stalled projects. Some clues to understanding the new series are provided in the chart below which decomposes the differences between the new series into those relating to real GDP growth and those to the deflator. This decomposition is shown sectorally. The largest discrepancies between the two series arise in 2013-14 and relate to real GDP growth for the manufacturing sector, where the magnitude is 6 percentage points! Even in 2012-13 the divergence between the two series in manufacturing is 5 percentage points. Jumps in the level of the manufacturing share of GDP can be attributed to the new methodology but it is still unclear why the rate of growth should diverge so much from previous estimates and from other indicators of manufacturing growth (viz. the index of industrial production). Even allowing for the fact that the latter is a volume index and the former a valued-added index, the discrepancy remains large. Clearly, these issues need to be examined in greater detail. Until a longer data series is available for analysis and comparisons, and until the changes can be plausibly ascribed to the respective roles of the new base, new data, and improved methodology, th....
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....e growth narrative of the last few years may elude a fuller understanding. Regardless, the latest numbers will have to be the prism for viewing the Indian economy going forward because they will be the only ones on offer. But, the balance of evidence and caution counsel in favour of an interpretation of a recovering rather than surging Indian economy. Economic Outlook, Prospects, and Policy Challenges 7 Figure: Difference between New and Old Estimates of Economic Growth, 2012-13 and 2013-14 (Per cent) 6 5 4 3 2 1 0 -1 2012-13 2013-14 2012-13 2013-14 -2 Growth new series-Growth old series Deflator new series-Deflator old series â– Agriculture & allied â– Industry â– Manufacturing Services Total Source: Central Statistics Office. determined by their nature: a positive shock that is perceived to be permanent should lead to larger consumption increases because the country's permanent income has increased; on the other hand, temporary positive shocks should lead to greater savings. What has India done? Given the uncertainty about the nature of the shock, India has appropriately hedged. Figure 1.4 below compares the decline in international crude- oil prices with the corresp....
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....onding decline in domestic retail prices of petrol and diesel. Since end-June 2014, the international price declined by about 50 percent. Of this, about 17 percent (representing about 34 percent of the overall decline) was passed on to consumers while the government retained the rest. In other words, 66 percent of the terms of trade shock went into the government's savings with the rest being passed on to consumers. (As detailed in section 1.12, the government's actions in this regard are also helping in form of a de-facto carbon tax.) Accounting for uncertainty about the future movement of prices, the macro-economic response has appropriately balanced savings and consumption, and by favouring the former, provided a necessary cushion to absorb the effects of higher oil prices in the future. 1.2B OUTLOOK FOR GROWTH In the short run, growth will receive a boost from lower oil prices, from likely monetary policy easing facilitated by lower inflation and lower inflationary expectations, and forecasts of a normal monsoon. Medium-term prospects will be conditioned by the "balance sheet syndrome with Indian characteristics," which has the potential to hold back rapid increases in private ....
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....sector investment. In the coming year, real GDP growth at market prices is estimated to be about 0.6-1.1 percentage points higher vis-a-vis 2014-15. This increase is warranted by four factors. First, the government has undertaken a number of reforms and is planning several more (Box 1.2). Their cumulative growth impact will be positive. A further impetus to growth will be provided by declining oil prices and increasing monetary easing facilitated by ongoing moderation in inflation. Simulating the effects of tax cuts, declining oil prices will add spending power to households, thereby boosting consumption and growth. Oil is also a significant input in production, and declining prices will shore up profit margins and hence balance sheets of the corporate sector. Declining input costs are reflected in the wholesale price index which moved to deflation territory in January 2015. 40 40 1-Apr-14 45 45 50 16-May-14 55 55 60 60 1-Jun-14 65 55 70 1-Jul-14 75 80 1-Aug-14 8 Economic Survey 2014-15 Further declines in inflation and the resulting monetary easing will provide policy support for growth both by encouraging household spending in interest-sensitive sectors and reducing the debt burd....
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....en of firms, strengthening their balance sheets. The final favourable impulse will be the monsoon which is forecast to be normal compared to last year. Using the new estimate for 2014-15 as the base, this implies growth at market prices of 8.1- 8.5 percent in 2015-16. The power of growth to lift all boats will depend critically on its employment creation potential. The data on longer-term employment trends are difficult to interpret because of the bewildering multiplicity of data sources, methodology and coverage (see Box 1.3). One tentative conclusion is that there has probably been a decline in long run employment growth in the 2000s relative to the 1990s and probably also a decline in the employment elasticity of growth: that is, a given amount of growth leads to fewer jobs created than in the past. Given the fact that labour force growth (roughly 2.2-2.3 percent) exceeds employment growth (roughly about 1½ percent), the challenge of creating opportunities will remain significant. 1.2C Outlook for reforms In the months ahead, several reforms will help boost investment and growth. The budget should continue the process of fiscal consolidation, embedding actions in a medium-ter....
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....m framework. India's overall revenue-to-GDP ratio (for the general government) for 2014 is estimated at 19.5 percent by the IMF. This needs to move toward levels in comparator countries—estimated at 25 percent for emerging Asian economies and 29 percent for the emerging market countries in the G-20. At the same time, expenditure control should Figure 1.4: Fall in International &Domestic Prices, April 2014 to February 2015 (Rs./ltr & US$/barrel) 31-Aug-14 1-Oct-14 1-Nov-14 Petrol Rs./ltr Diesel Rs./ltr Crude oil (Indian Basket) US$/bbl (RHS) Source: PPAC, Ministry of Petroleum & Natural Gas and PIB, Govt. of India. Note: Prices for petrol and diesel are all India average. 4.http://www.skymetweather.com/content/weather-news-and-analysis/el-nino-scare-abandoned-normal-indian- monsoon-likely-in-2015/ 1-Dec-14 17-Jan-15 4-Feb-15 20 40 30 880 90 80 70 60 50 100 120 110 Economic Outlook, Prospects, and Policy Challenges 9 Box 1.2: Reform Actions of the New Government Since assuming office in May 2014, the new government has undertaken a number of new reform measures whose cumulative impact could be substantial. These include: • Deregulating diesel prices, paving the way for n....
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....ew investments in this sector; • Raising gas prices from US$ 4.2 per million British thermal unit to US$ 5.6, and linking pricing, transparently and automatically, to international prices so as to provide incentives for greater gas supply and thereby relieving the power sector bottlenecks; Taxing energy products. Since October, taking advantage of declining oil prices, the excise tax on diesel and coal was increased four times. In addition to resulting in collections of about 70,000 crore (on an annualized basis), this action will have positive environmental consequences, as explained in section 1.12; • Replacing the cooking gas subsidy by direct transfers on a national scale; • Instituting the Expenditure Management Commission, which has submitted its interim report for rationalizing expenditures; • Passing an ordinance to reform the coal sector via auctions; • Securing the political agreement on the goods and services tax (GST) that will allow legislative passage of the constitutional amendment bill; ◠Instituting a major program for financial inclusion—the Pradhan Mantri Jan Dhan Yojana under which over 12.5 crore new accounts have been....
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.... opened till mid-February 2014; Continuing the push to extending coverage under the Aadhaar program, targeting enrollment for 1 billion Indians; as of early February, 757 million Indians had been bio-identified and 139-Aadhaar linked bank accounts created; Increasing FDI caps in defense; • Eliminating the quantitative restrictions on gold; • Passing an ordinance to make land acquisition less onerous, thereby easing the cost of doing business, while ensuring that farmers get fair compensation; Facilitating Presidential Assent for labour reforms in Rajasthan, setting an example for further reform initiatives by the states; and consolidating and making transparent a number of labour laws; and • Passing an ordinance increasing the FDI cap in insurance to 49 percent. Commencing a program of disinvestments under which 10 percent of the government's stake in Coal India was offered to the public, yielding about *22,500 crore, of which 5,800 crore was from foreign investors; Passing the Mines and Minerals (Development and Regulation) (MMDR) Amendment Ordinance, 2015 is a significant step in revival of the hitherto stagnant mining sector in the country. The process of aucti....
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....on for allotment would usher in greater transparency and boost revenues for the States. be consolidated while ensuring that there is switching from public consumption to public investment, with a focus on eliminating leakages and improving targeting in the provision of subsidies. To provide legal certainty and confidence to investors, the ordinances on coal, insurance, and land need to be translated into legislation approved by Parliament. At the same time, the constitutional amendment bill to implement the goods and services tax (GST) also needs to be enshrined in legislation first by Parliament followed by ratification by the States. A single GST rate (across States and products) set at internationally competitive levels with limited exemptions would maximize its pro-growth, pro-compliance, and pro-single market creating potential. While the framework for a modern and comprehensive indirect tax system is being put in place with the GST, parallel efforts are required 10 Economic Survey 2014-15 Box 1.3: Employment Growth and Employment Elasticity: What is the Evidence? Estimates of employment growth and its elasticity relative to economic growth vary widely. However, tentatively, ....
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....one might say that employment growth and elasticity have declined in the 2000s compared to the 1990s. Since labour force growth is in excess of employment growth, labour absorption will be a challenge. Reforms and faster economic growth will be central to meeting it. If the new GDP estimates have raised questions about our understanding of recent economic developments, deciphering patterns of employment growth is no less a challenge. There is almost a bewildering variety of estimates on employment growth in India. Data come from multiple sources, for different time periods, coverage and sample sizes, with varying methodologies. These are described in the table below. Table: Periodicity, Coverage and Population size of different Data Sources Sl. Data Source Periodicity Sector Coverage 1 Census Decadal All 2 Labour Bureau (LB) Annual All National Sample Quinquennial All Survey (NSS) 4 Economic Census (EC) No fixed periodicity 5 Annual Survey of Industries (ASI) Annual Notes: All establishments including the unorganized sector and excluding crop production, plantation, public administration, defence and compulsory social security. All factories registered under Sections 2m(i) and 2m(i....
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....i) of the Factories Act, 1948 all electricity undertakings engaged in generation, transmission and distribution of electricity registered with the Central Electricity Authority (CEA) 1. Census classifies employed as main and marginal. 2. NSS accounts for both principal and subsidiary status of employment. Population/Sample Population Sample (1.37 lakh households, 6.80 lakh persons in 2013-14 survey) Sample (1.02 lakh households, 4.57 lakh persons in 2011-12 round) Sample (25 lakh households, 56 million establishments in 2014 EC) 2.17 lakh factories in 2012-13 survey 3. From the Labour Bureau survey, we estimate population for the age group 15 and above. 4. For ASI data from 2000-01 to 2003-04, the census field was modified to include units employing 100 and more workers instead of 200 and more workers. Therefore post 2000-01 data are not strictly comparable with that of previous rounds. What do these sources tell us about employment growth and the elasticity of employment growth with respect to GDP growth for the 1990s and 2000s?¹ The results are summarized in the table below. Economic Outlook, Prospects, and Policy Challenges 11 Table: Employment Growth And Employment Elasticit....
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....ies CENSUS NSS LABOUR ECONOMIC ASI BUREAU CENSUS 1991 2001 1993-94 1999-00 2011-12 to to to 1999- to to 1990 to 1998 1990-91 2003-04 2001 2011 2000 2011-12 2013-14 1998 to 2014 1998-99 2012-13 to to Change in Employment 88.4 79.2 25.5 73.4 9.15 12.9 44.4 0.43 5.07 (million) Employment Growth 2.5 GDP Growth 1.8 1.1 1.4 1.0 2.1 2.7 0.6 5.7 5.7 7.7 6.8 7.3 4.6 6.1 6.6 5.5 10.7 Employment Elasticity 0.44 0.24 0.16 0.19 0.22 0.35 0.41 0.12 0.54 A few very tentative conclusions can be drawn from what are fairly noisy estimates. Aggregate employment growth has been above 2 percent in the 1990s. The Census and Economic Census are fairly close to each other in this regard, although the NSS data paints a different picture. Employment growth declines to between 1.4 and 1.8 percent in the 2000s according to both the Census and NSS. In contrast, employment growth in organized industry exhibits the opposite temporal pattern, with substantially higher employment growth in the 2000s compared with the 1990s. A similar pattern is suggested for the employment elasticity of growth: higher elasticity of about 0.35- 0.44 in the 1990s and a drop to close to 0.2 in the 2000s. The most recent data from the....
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.... Labour Bureau indicates that since 2011-12 too, the employment elasticity has remained low. Employment absorption was evidently less successful in the last decade. Regardless of which data source is used, it seems clear that employment growth is lagging behind growth in the labour force. For example, according to the Census, between 2001 and 2011, labor force growth was 2.23 percent (male and female combined). This is lower than most estimates of employment growth in this decade of closer to 1.4 percent. Creating more rapid employment opportunities is clearly a major policy challenge. 'In computing the employment elasticity, consistency of coverage between the employment and growth data is ensured to the extent possible. For example, for EC data, manufacturing GDP is used as the relevant base; while for ASI data gross value addition (deflated by Manufacturing GDP) is used as the base in the computations. References: Misra, Sangita and Anoop K Suresh “Estimating Employment Elasticity of Growth for the Indian Economy", 2014, RBI Working Paper Series 6. Mehrotra, Santosh “Explaining Employment Trends in the Indian Economy: 1993-94 to 2011-12â€, 2014, Economic and Pol....
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....itical Weekly, XLIX(32). on the direct tax side. The objective should be to create a competitive, predictable, clean, and exemptions-light tax policy regime that will lower the cost of capital, incentivize savings, and facilitate taxpayer compliance. The government and the RBI need to conclude the monetary policy framework agreement to consolidate the recent gains in inflation control and codify into an institutional arrangement what has become the de facto practice. This would signal that both government and RBI jointly share the objectives of low and stable inflation. Reforms of labor and land laws and reducing the costs of doing business will need to be a joint endeavor of the States and Center (see Box 3 of the Mid-Year Economic Analysis 2014-15 for an elaboration). The game-changing potential of implementing the GST and moving to technology- enabled Direct Benefit Transfers—which we call the JAM (Jan Dhan-Aadhaar-Mobile) Number Trinity solution-should not be underestimated. 12 Economic Survey 2014-15 1.3 INFLATION AND MONEY Structural shifts in the inflationary process are underway caused by lower oil prices and deceleration in agriculture prices and wages. These are si....
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....multaneously being reflected in dramatically improved household inflation expectations. The economy is likely to over- perform on the RBI's inflation target by about 0.5-1.0 percentage point, opening up the space for further monetary policy easing. As elaborated in the Mid-Year Economic Analysis 2014-15, the evolution in inflation has surprised market participants and policy makers, including the RBI. The momentum, measured as the three month average seasonally adjusted and annualized, has declined from nearly 15 percent to below 5 percent (Figure 1.5).5 Interestingly, the momentum of food prices has declined even more and is at levels below overall inflation. Going forward, this momentum is likely to persist because of three striking developments in three areas that signal a structural shift in the inflationary process in India: crude-oil, agriculture, and inflation expectations. Crude-oil prices are expected to remain benign in the coming months. Indeed, the average of estimates by the IMF for (crude spot) and by the US Energy Information Administration (EIA) for Brent and West Texas Intermediate crude indicates that oil prices will be about 29 percent lower in 2015-16 compared w....
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....ith 2014-15 (US$ 59 versus US$ 82) (Figure 1.6). The risk that the decline in oil prices will reverse itself always exists because of unpredictable geo- political developments. However, the persistence of moderated oil prices seems highly probable for at least three reasons: weaker global demand, increased supplies, and the global monetary and liquidity environment. Demand will remain soft because of slow growth in major areas of the world economy, including China and Europe. Supply shifts are occurring related to the increase in crude-oil and shale gas production in the US and the concomitant decline in the oligopolistic power of OPEC, notably its swing producer, Saudi Arabia (which decided not to react to the increase in supply from other sources). Going forward, prices could increasingly be determined by the marginal cost of shale production estimated at around US$ 60-65 per barrel.6 Finally, the anticipated end to the abnormally low interest cycle in the US and the prospect of future rate increases will favour extraction of oil over keeping it in the ground, thereby further boosting supply and keeping prices soft. Higher rates will also lead to financial asset-reallocation away....
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.... from commodities, especially oil, as a class into US financial instruments. One lesson of the 2000s is instructive. This decade witnessed an across-the-board increase in commodity prices partly on account of excess liquidity, created by synchronized monetary policy easing in the advanced countries. That synchronization has been broken by the diverging macro-economic paths of the United States, where recovery will lead to a reversion to normal monetary policy, on the one hand, and Europe and Japan, on the other, where policies may remain loose. Of course, if China starts slowing and responds through a combination of cheaper credit and a depreciating exchange rate, global liquidity could surge again but the US will still be in tightening mode. Second, in addition to oil prices, India's inflation will be shaped by pressures from agriculture, foreign and domestic. According to World Bank projections, global agricultural prices will remain muted- a likely decline of 4.8 percent in 2015 5 Figure 1.5 is based on the new, re-based (from 2010 to 2012) CPI index. 6 Arezki, R & Olivier Blanchard, "The 2014 oil price slump: Seven key questions", January 2015 accessed at http://www.voxeu.org/a....
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....rticle/2014-oil-price-slump-seven-key-questions. Economic Outlook, Prospects, and Policy Challenges Figure 1.5: Momentum of CPI (base 2012), December 2012 to December 2014 (Per cent) SAAR (%) 25 20 15 10 0 -5 CPI headline CPI Food & beverages -10 1 1 1 1 1 1 1 1 1 1 1 1 1 Source: CSO. Figure 1.6: Future Price of Brent Crude up to December 2017 (US$ per barrel) 90 85 80 75 70 65 60 55 50 Source: Thomson Reuters. ▬▬▬▬▬▬▬▬ Future Price as on 1 December 2014 Future Price as on 1 January 2015 Future Price as on 11 February 2015 13 Nov-05 Source: Labour Bureau. Nov-06 5 Nov-07 10 Nov-08 15 Nov-09 20 20 Nov-10 14 Economic Survey 2014-15 relative to 2014. This will likely have a key impact in moderating increases in domestic support prices.7 The most dramatic structural change relates to wage pressures. As shown in Figure 1.7, wage growth has declined to about 3.6 percent from over 20 percent. If these trends continue, rural wage growth can continue to decelerate, further moderating inflationary pressures. The third factor relates to inflation expectations. Until recently, household surveys of inflation expectation conducted by the RBI showed....
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.... that expectations have been stubbornly persistent and at levels well above actual inflation. But in the most recent survey they dropped by nearly 7-8 percentage points over all horizons (Figure 1.8). If this change conveys some information, inflation expectations will increasingly be anchored at more reasonable levels, moderating wage setting. In sum, the structural shift that was argued in the Mid-Year Economic Analysis 2014-15 seems well under way. Consumer price inflation which is likely to print at 6.5 percent for 2014-15 is likely to decline further. Our estimate for 2015-16 is for CPI inflation to be in 5.0-5.5 percent range and for the GDP deflator to be in the 2.8-3.0 percent range. The implication is that the economy will over-perform on inflation which would clear the path for further monetary policy easing. Trends in financial markets suggest that there has been a gradual easing of deposit rates in recent few months as yields on 10 year government bonds have been falling consistently during this period (Figure 1.9). Declining yields could trigger Figure 1.7: Rural Wage Growth, November 2005 to November 2014 (Per cent) 25 7 The domestic production of oilseeds and pulses ....
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....is likely to be below target, but greater imports could help dampen inflationary impulses from this sector. Nov-11 Nov-12 Nov-13 --- Nov-14 Source: RBI. 14 Median Inflation Rate (%) 10 18 16 Economic Outlook, Prospects, and Policy Challenges Figure 1.8: Household Inflation Expectations, September 2008 to December 2014 (Per cent) Sep-08 Dec-08 Mar-09 Jun-09 Sep-09 Dec-09 Mar - 10 Jun - 10 Sep-10 Dec-10 Mar - 11 Current Jun - 11 Three-month ahead Sep - 11 Dec-11 Mar - 12 Jun - 12 Sep-12 Dec-12 Mar - 13 Jun - 13 Sep-13 Dec-13 Mar-14 Jun - 14 Sep-14 One-year ahead reduction in lending rates by banks in the coming months. With the easing of inflationary conditions, the RBI has already signalled a shift in the monetary policy stance when it cut policy repo rates by 25 basis points to 7.75 percent in January 2015. In some ways, further monetary policy easing would entail the policy rate catching up with market rates. Liquidity conditions have remained broadly balanced so far during 2014-15. The implementation of a revised liquidity management framework has helped in reducing volatility in the overnight inter-bank segment and better anchoring the call rate near the policy rate. With the fi....
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....scal deficit to remain under control and the new liquidity management framework in place, liquidity conditions are expected to remain comfortable in 2015-16. 1.4 EXTERNAL SECTOR The outlook is favourable for the current account and its financing. A likely surfeit, rather than scarcity, of foreign capital will complicate exchange rate management. Risks from a shift in US monetary policy and turmoil in the Eurozone need to be watched but could remain within control. The outlook for the external sector is perhaps the most favourable since the 2008 global financial crisis, and especially compared to 2012-13, when elevated oil and gold imports fuelled a surge in the current account deficit. Global crude petroleum prices averaged about US$ 47/ bbl in January 2015 and about US$ 90/bbl for the year as a whole (April 2014-January 2015). Assuming a further moderation in average annual price of crude petroleum and other products, the current account deficit is estimated at about 1.3 per cent of GDP for 2014-15 and less than 1.0 per cent of GDP in 2015-16. A rule of thumb is that a US$10 reduction in the price of oil helps improve the net trade and hence current account balance by US$ 9.4 bill....
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....ion. Moderated gold imports will also help sustain a manageable current account deficit. Since the elimination of restrictions on gold in November, gold imports have fallen well below the elevated levels seen in 2013. Declining international prices as well as moderating inflation have meant that gold imports averaged US$ 1.3 billion in December 2014 and US$ 1.6 billion in January 2015 compared with US$ 4.2 billion in October 2014 and US$ 5.6 billion in November 2014. Dec-14 15 7.0 7.5 8.0 01/Jul/14 07/Jul/14 13/Jul/14 8.5 16 Economic Survey 2014-15 Figure 1.9: Bond Yields, July 2014 to February 2015 (Per cent) 10.0 9.0 9.5 31/Jul/14 +1/8/90 12/Aug/14 18/Aug/14 24/Aug/14 30/Aug/14 04/Nov/14 10/Nov/14 16/Nov/14 22/Nov/14 28/Nov/14 04/Dec/14 10/Dec/14 16/Dec/14 22/Dec/14 28/Dec/14 03/Jan/15 03/Jan/15 09/Jan/15 15/Jan/15 21/Jan/15 27/Jan/15 02/Feb/15 08/Feb/15 10-year g-sec yield Source: Bloomberg. 10-year AAA corporate bond yield The outlook for external financing is correspondingly favourable, and surfeit rather than scarcity may pose the greater challenge. Financial flows in 2014-15 are likely to be in excess of US$ 55 billion, leading to a sizeable accretion to reserves by about US....
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....$ 26 billion, to about US$ 340 billion (Figure 1.10). This has been facilitated by extensive RBI exchange market intervention. These inflows are likely to continue through a large part of 2015-16. A key implication is that if the current account deficit is lower, a given level of capital inflows will create greater upward pressure on the rupee. One source of concern is muted export growth and rising non-oil, non-gold imports which could be affected by India's deteriorating competitiveness, reflected in the appreciation of the real effective exchange rate by 8.5 per cent since January 2014. The interesting fact here is that higher inflation in India relative to trading partners is contributing only 2.3 percentage points, with the remaining 6.2 percentage points accounted for by the rupee strengthening in nominal terms against other currencies. In other words, surging capital inflows, notwithstanding the intervention by 5-year AAA corporate bond yield the RBI both in spot and forward markets, accounts for the bulk of the deteriorating competitiveness. Reconciling the benefits of these flows with their impact on exports and the current account remains an important challenge going forw....
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....ard. The RBI, in other words, will be on the trident of the macro- economic trilemma, struggling to reconcile capital account openness and surging inflows, monetary policy independence, and the economy's competitiveness. Four factors pose risks to the external situation: • . renewed financial market volatility in response to US Federal Reserve monetary tightening which is expected later this year; possible turmoil if the viability of the Eurozone were to come into question in the event of a Greek exit; a spike in oil prices related to geopolitical events; and a slowly deteriorating international trade environment. Economic Outlook, Prospects, and Policy Challenges Figure 1.10: Foreign Exchange Reserves, February 2013 to January 2015 (US$ billion) 350 330 310 290 270 250 Jan-13 Feb -13 Mar - 13 Apr -13 May -13 Jun - 13 Reserves Jul-13 Aug-13 Sep-13 Oct-13 Nov-13 Dec-13 Jan-14 Feb -14 Mar - 14 Apr -14 May-14 Jun - 14 Jul-14 Aug-14 Sep-14 Oct-14 Nov-14 Dec - 14 Jan-15 Reserves adjusted for outstanding forward position Source: RBI. Two points are worth noting on the risks emanating from the Fed and Eurozone. First, India may be vulnerable because a substantial portion of the fore....
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....ign flows since March 2014 are interest sensitive. Of the total portfolio cumulative flows (US$ 38.4 billion), about US$ 23.8 billion have been portfolio debt flows. The decline in yields on government and corporate bonds shown in Figure 1.9 reflects these flows. Fed tightening could lead to reversal of some of these inflows, placing downward pressure on the rupee. However, India is more resilient today than in 2014 or 2013 not only because of greater reserves, but more importantly, due to a healthier macro- economic position. While complacency is never warranted, over-anxiety should also be kept at bay. In the medium-term, it is perhaps the trade challenge that is a greater source of concern (see section 1.11 below). A larger issue on the external front is geo-strategic. If power used to flow from the barrel of a gun, in an increasingly inter-dependent economic world, Figure 1.11: Nominal and Real Effective Exchange Rates-Export-Based Indices, July 2013 to January 2015 116 114 77 112 ་ 110 108 106 104 102 100 Source: RBI. Jul-13 Aug-13 | REER - Export based weight Oct-13 Nov-13 Dec-13 Jan-14 Feb-14 Mar-14 Apr-14 May-14 June-14 July-14 Aug-14 Sep-14 Oct-14 Nov-14 Dec-14 NEER ....
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....- Export based weight (RHS) Jan-15 69 71 73 75 17 18 Economic Survey 2014-15 hard and soft power derive from a war-chest of foreign exchange reserves. China's abundant reserves have highlighted this fact. Reserves provide a cushion against shocks, creating economic and financial resilience. But they also create geo-political influence. Today, China has de-facto become one of the lenders of last resort to governments experiencing financial troubles. It has also become one of the bigger providers of development assistance both bilaterally and plurilaterally. China, in its own heterodox and multiple ways, is assuming the roles of both an International Monetary Fund and a World Bank as a result of its reserves. The acquisition of reserves is not costless because it requires a policy of mercantilism and consequential distortion of financial and exchange markets. But there is a cost-benefit analysis that needs to be undertaken. The question for India, as a rising economic and political power, is whether it too should consider a substantial addition to its reserves, preferably its own reserves acquired though running cumulative current account surpluses, possibly targeting a level of US$ ....
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....750 billion-1 trillion over the long run. 1.5 AGRICULTURE The First Advance Estimate of Kharif crops (July- September 2014) indicates lower production compared to the last year. However, the estimate is generally revised upwards. The Rabi crops data released by the Directorate of Economics and Statistics recently indicates that although the total area coverage has declined, area under wheat has gone down marginally by 2.9 per cent. Nevertheless, for 2014-15, the CSO has estimated a positive growth rate of 1.1 per cent for agriculture despite lower rainfall that was only 88 per cent of long-period average, and following a bumper year in 2013-14. The CSO estimate is value-added while agricultural production data are volume based, hence positive agricultural GDP growth is not inconsistent with volume declines because input costs have declined sharply. But perhaps a deeper shift in agriculture may be under way which calls for greater attention to this sector. The decade long shift in the terms of trade toward agriculture may have come to an end as global agricultural prices have peaked. This is illustrated in figure 1.12 which plots the terms of trade for agriculture according to two d....
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....ifferent measures. Both show a slow decline after 2010- 11, following several years of improvement. As the terms of trade deteriorate and as rural incomes come under pressure (see also Figure 1.7), the political pressure for support will increase. Already, there have been proposals to raise tariffs in a number of sectors like oilseeds and pulses and to provide export subsidies in sugar. One response in the short run must be to enhance targeted support for the vulnerable in agriculture, namely the small farmer and agricultural labourer. The MGNREGA program has the virtue of being reasonably well-targeted. The challenge here is to build on this feature and use the program to build assets such as rural roads, micro-irrrigation and water management, while also shoring up rural incomes. In the medium-term, the time is ripe for a more broad-based response to the challenges in agriculture and to ensure that agriculture grows at about 4 percent on a sustained basis. One of the most striking problems is how unintegrated and distortions-ridden are our agricultural markets (see chapter 8 of this volume, which also offers possible solutions). India needs a national common market for agricultur....
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....al commodities by making the Agricultural Produce Market Committees (APMCs) just one among 8 The TOT indices are based on the following formulae adopted by the Group (WG) in May 2012 under the chairmanship of Professor S. Mahendra Dev. (1) Index of Terms of Trade = Index of Price Received for Farm Products Index of Price Paid for Farm Inputs, Final Consumption and Capital Investment X100 (2) Index of Terms of Trade = Index of Price Received for Farm Products and Agricultural Wages Index of Price Paid for Farm Inputs, Final Consumption and Capital Investment X100 Economic Outlook, Prospects, and Policy Challenges 19 Figure 1.12: Index of Agricultural Terms of Trade, 2004-05 to 2013-14 105 100 95 95 90 85 80 75 70 2004-05 2005-06 2006-07 2007-08 2008-09 ITT - farmer & non-farmer Source: Refer to footnote 8. 2009-10 2010-11 2011-12 ITT - agriculture & non-agriculture 2012-13 2013-14(P) many options available for the farmers to sell their produce. Rationalisation of subsidies and better targeting of beneficiaries through direct transfers would generate part of the resources for the public investment that is essential in research, education, extension, irrigation, water-management, soil....
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.... testing, warehousing and cold-storage. Distortions emerging from various policies, including, exempting user charges for electricity and water need to be reduced, though better targeting and eliminating leakages. The recommendations of the Shanta Kumar Committee provide useful suggestions for the future road-map of food-policy. The functioning of the Food Corporation of India needs to be revamped substantially. There are also wide differences in the yields within states. Even the best of the states have much lower yield in different crops when compared to the best in the world. This is evident from the Table 1.1 below. Vast amounts of cropped area (approximately 41 percent) are still unirrigated. Providing irrigation can improve yields substantially. For a shift in the underlying production function, investment in basic research will be necessary. This provides ample zone. opportunity to increase production by bridging the yield-gap to the extent feasible within the climatic Institutionally, the time may be ripe for re- assessing the role of the Indian Council of Agricultural Research (ICAR), its relationships with the state agricultural universities as well as with individual ins....
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....titutes (say the Indian Agricultural Research Institute or the National Dairy Research Institute), and whether research, education, and extension should be separated. To provide efficient advance price-discovery to farmers and enable them to hedge price risks the Forward Markets Commission is being strengthened. The concern that there may be unnecessary speculation should be addressed though more effective regulation along the lines of the recommendations made by the Financial Sector Legislative Reforms Commission (FSLRC). 1.6 THE GROWTH-FISCAL POLICY CHALLENGE India can balance the short-term imperative of boosting public investment to revitalize growth with the need to maintain fiscal discipline. Expenditure control and expenditure switching, from consumption to investment, both in the upcoming budget and in the medium term will be key. 20 Economic Survey 2014-15 Table 1.1: Crop Yield Comparison: India versus the World Crop Paddy Wheat Maize Chickpeas Cotton Rapeseed/Mustard Seed India Highest Yield (State) Punjab - 3952 Punjab - 5017 Tamil Nadu -5372 Andhra Pradesh - 1439 Punjab - 750 Gujarat - 1723 Note: Figures are in yield/kg/hectare and pertain to 2012. The Medium-Term Fisca....
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....l Framework Notwithstanding the challenging nature of the 2014-15 budget, elaborated in the Mid-Year Economic Analysis 2014-15, the Government will adhere to the fiscal target of 4.1 per cent of GDP. Despite weakness in revenue collection and delayed disinvestment, new excises on diesel and petrol (revenue yield of about Rs. 20,000 crores), reduced subsidies, and expenditure compression will ensure the commitment to discipline. India can reconcile the requirements of fiscal consolidation and the imperative of boosting public investment to revive growth and crowd-in private investment provided the right lessons are learnt. How so? Since this is the first full budget of the new government, and especially in light of the far- reaching recommendations of the Fourteenth Finance Commission, the time is ripe for reviewing the medium-term framework and setting targets for the upcoming year against that background and taking account of the lessons of recent history (Figure 1.13). Three phases marked recent fiscal history. In the first (2002-08), rapid growth improved all fiscal aggregates, flows and stocks. But failure to control expenditure, especially revenue expenditure, towards the end ....
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....of that phase, combined with excessive counter-cyclical policies in the second phase (2009-12) led to a loss of fiscal control that contributed to the near-crisis of 2013. A casualty has been low and stagnating capital expenditure. In the third phase (2013-today), a modicum of World Highest Yield China - 6661 UK-7360 USA - 8858 Ethiopia - 1663 Australia 1920 UK-3588 fiscal stability has been restored. This history suggests the following strategy going forward. First, in the medium term, India must meet its medium-term target of 3 percent of GDP. This will provide the fiscal space to insure against future shocks and also to move closer to the fiscal performance of its emerging market peers. It must also reverse the trajectory of recent years and move toward the ‘golden rule' of eliminating revenue deficits and ensuring that, over the cycle, borrowing is only for capital formation. Second, the way to achieve these targets will be expenditure control and expenditure switching from consumption to investment. And the secular decline in capital expenditure in the last decade has undermined India's long run growth potential. From 2016-17, as growth gathers steam and as the GST is im....
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....plemented, the consequential tax buoyancy when combined with expenditure control will ensure that medium term targets can be comfortably met. This buoyancy is assured by history because over the course of the growth surge in the last decade, the overall tax-GDP ratio increased by about 2.7 percentage points, from 9.2 percent in 2003-04 to 11.9 per cent in 2007-08 even without radical tax reform. Third, the medium-term commitment to discipline cannot result in an Augustinian deferment of actions. In the upcoming year, too, fiscal consolidation must continue. However, the need for accelerated fiscal consolidation has lessened because macro- economic pressures have significantly abated with the dramatic decline in inflation and turnaround in the current account deficit. In these circumstances, 2002-03 2 2003-04 4 2004-05 6 2005-06 8 10 2006-07 12 2007-08 14 2008-09 Economic Outlook, Prospects, and Policy Challenges 21 Figure 1.13: Recent Fiscal History, 2002-03 to 2014-15 (Percent of GDP) 16 Growth drives fiscal improvement Loss of fiscal control due to counter-cyclical tax policy and high expenditures Gradual stabilization 70 70 2009-10 2010-11 2011-12 2012-13 2013-14 Total outstandi....
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....ng liabilities (RHS) Revenue expenditure Source: Budget Documents and CSO. Fiscal deficit Non-defence capital Note: Numbers for 2013-14 and 2014-15 are revised estimates and budget estimates, respectively. especially if the economy is recovering rather than surging, pro-cyclical policy is less than optimal. Debt dynamics also remain favourable going forward, ensuring a steady strengthening of public sector balance sheets. Further, accelerated fiscal consolidation will have to be conditioned in the upcoming fiscal year by a number of new and exceptional factors, such as implementing the recommendations of the Fourteenth Finance Commission, clearing the compensation obligations to the states for the reduction in the central sales tax in 2007-08 and 2008-09, and the need to increase public investment. Nevertheless, to ensure fiscal credibility, and consistency with the medium-term goals, the upcoming budget should initiate the process of expenditure control to reduce both the fiscal and revenue deficits. At the same time, the quality of expenditure needs to be shifted from consumption, by reducing subsidies, toward investment. Broadly speaking, the additional space opened up, includin....
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....g through a reduction in subsidies and higher disinvestment proceeds, should be occupied by public investment. Increases in the tax-GDP ratio, stemming from the excise tax increases on petroleum products, will also help achieve both short and medium term fiscal goals. 1.7 WIPING EVERY TEAR FROM EVERY EYE: THE JAM NUMBER TRINITY SOLUTION The debate is not about whether but how best to provide active government support to the poor and vulnerable. Cash-based transfers based on the JAM number trinity-Jan Dhan, Aadhaar, Mobile-offer exciting possibilities to effectively target public resources to those who need it most. Success in this area will allow prices to be liberated to perform their role of efficiently allocating resources and boosting long-run growth. Sixty eight years after Independence, poverty remains one of India's largest and most pressing problems. No nation can become great when the life chances of so many of its citizens are benighted by poor nutrition, limited by poor learning opportunities, and shrivelled by gender discrimination (discussed in section 1.13). The 2014-15 40 40 45 50 50 55 555 60 60 65 65 22 Economic Survey 2014-15 recent Annual Survey of Education Repo....
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....rt (ASER), which shows stagnation in learning outcomes over the past decade, makes for sobering reading (see Box in Volume 2, Chapter 9). Economic growth is good for the poor, both directly because it raises incomes and because it generates resources to invest in the public services and social safety nets that the poor need. Growth ― and the prospects and opportunities that it brings - also encourages individuals to invest in their own human capital. A recent study found strikingly that merely informing families in villages outside Bangalore that call centres were hiring educated women increased the likelihood that adolescent girls in those villages completed schoolâ¹. However, growth must be complemented with effective state-delivered programs that raise the living standards of the most vulnerable in society. To be successful, anti-poverty programs must recognise that policies shape the incentives of individuals and firms, and also acknowledge the limited implementation capacity of the state to target and deliver public services to the poor. Both the central and state governments subsidise a wide range of products with the expressed intention of making these affordable ....
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....for the poor. Rice, wheat, pulses, sugar, kerosene, LPG, naphtha, water, electricity, fertiliser, iron ore, railways - these are just a subset of the products and services that the government subsidises. The estimated direct fiscal costs of these (select) subsidies are about 378,000 crore or about 4.2 percent of GDP. This is roughly how much it would cost to raise the expenditure of every household to that of a household at the 35th percentile of the income distribution¹0 (which is well above the poverty line of 21.9 percent¹¹). Table 1.2 below presents some rough, illustrative estimates of the cost of these subsidies and who benefits from them. Price subsidies, no doubt provide help, but they may not have a transformative effect on the economic lives of the poor. For many subsidies, only a small fraction of the benefits actually accrue to the poor. For example, electricity subsidies benefit mainly the (relatively wealthy) 67.2 percent of households that are electrified ¹². A large fraction of subsidies allocated to water utilities are spent on subsidising private taps when 60 percent of poor households get their water from public taps¹³. Moreover, the implemen....
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....tation of subsidies can be fiendishly complex. In the case of fertilizers, they are firm-specific and import-consignment specific, they vary by type of fertilizer, and some are on a fixed-quantity basis while others are variable. Subsidies are also susceptible to the brutal logic of self-perpetuation. In the case of sugar, to protect sugar cane producers high support prices are awarded; to offset this tax on mill owners, they are supported through subsidized loans and export subsidies; and then they are again taxed by placing restrictions on sales of molasses that are produced as a by-product. Different subsidies also interact to hurt the poor. For example, fertiliser manufacturers do not have the incentive to sell their product in hard-to-access regions, since price controls mean that prices are similar everywhere, so freight subsidies on railways have been introduced to incentivise manufacturers to supply their produce widely. But those subsidies are sometimes insufficient, since freight rates are among the highest in the world, and intentionally so, to cross-subsidise artificially low passenger fares. This is an example of how a mesh of well- meaning price controls distort incen....
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....tives in a way that ultimately hurt poor households. 9 Jensen, Robert, "Do Labor Market Opportunities Affect Young Women's Work and Family Decisions? Experimental Evidence from India" 2012, Quarterly Journal of Economics. 10 Economic Survey of India 2014-15, Vol. I, Chapter 3. 11 Planning Commission, July 2013, reporting on the Tendulkar Commission (http://planningcommission.nic.in/ news/pre_pov2307.pdf) 12 Census of India (2011), Source of Lighting. 13 Do Current Water Subsidies reach the poor?, MIT and World Bank working paper (http://web.mit.edu/ urbanupgrading/waterandsanitation/resources/pdf-files/WaterTariff-4.pdf) Economic Outlook, Prospects, and Policy Challenges 23 Table 1.2: How much do subsidies benefit the poor Product Producer subsidy Consumer subsidy Fiscal Fiscal expenditure expenditure (Cr.) (percent of 2011-12GDP) Railways N/A Subsidised 51,000 0.57 passenger fares¹ Liquefied N/A petroleum gas Subsidy (now via DBT) 23,746 0.26 Kerosene N/A Subsidy via PDS 20,415 0.23 nitrogenous commodities Fertiliser & Firm and nutrient Maximum 73,790 0.82 specific subsidies to manufacturers. Import of urea regulated by Rice (paddy) Wheat the government Price floor (minimum sup....
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....port price) Subsidy via PDS 129,000 1.14 Pulses Price floor (MSP) Electricity Subsidy Subsidy via PDS Capped below market price 158 0.002 32,300 0.36 Water N/A Subsidy 14,208 0.50 Sugar for sugar cane farmers, Minimum price Subsidy via PDS 33,000 0.37 subsidy to mills Total 377,616 4.24 What share of benefits accrue to the poor? The bottom 80 percent of households constitute only 28.1 percent of total passenger through fare on railways The bottom 50 percent of households only consume 25 percent of LPG 41 percent of PDS kerosene allocation are lost as leakage, and only 46 percent of the remainder is consumed by poor households Urea and P&K manufacturers derive most economic benefit from the subsidy, since farmers, especially poor farmers, have elastic demand for fertiliser 15 percent of PDS rice is lost as leakage. Households in the bottom 3 deciles consume 53 percent of the remaining 85 that reaches households percent 54 percent of PDS wheat is lost as leakage. Households in the bottom 3 deciles consume 56 percent of the remaining 46 percent that reaches households The bottom 3 deciles consume 36 percent of subsidised pulses Average monthly consumption of bottom quintile = 45 kWh v....
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....s top quintile = 121 kWh. Bottom quintile captures only 10 percent of the total electricity subsidies, top quintile captures 37 percent of subsidy Most water subsidies are allocated to private taps, whereas 60 percent of poor households get their water from public taps 48 percent of PDS sugar is lost as leakage. Households in the bottom 3 deciles consume 44 percent of the remaining 52 percent that reaches households All expenditure deciles are based on data from the household expenditure module of the 68th Round of the NSS (2011-12) Railways - www.ncaer.org/free-download.php?pID=111,p107 & NSS 68th round LPG-Computations from the 68th Round of the NSS (2011-12) Kerosene - Economic Survey of India 2014-15, Vol. I, Chapter 3. Fertiliser - Agricultural Input Survey, http://inputsurvey.dacnet.nic.in/nationaltable3.aspx Rice & wheat - Economic Survey of India 2014-15, Vol. I, Chapter 3. Pulses Computations from the 68th Round of the NSS (2011-12) Water - Report by MIT and World Bank http://web.mit.edu/urbanupgrading/waterandsanitation/resources/pdf- files/WaterTariff-4.pdf, p2 Sugar - Department of Food & Public Distribution (http://dfpd.nic.in/fcamin/sugar/Notice1.pdf) 24 Economic Surv....
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....ey 2014-15 Fertiliser subsides illustrate another difficulty with using price subsidies as a core anti-poverty strategy. The true economic incidence of a subsidy depends on the relative elasticities of demand and supply, with the party less responsive to price changes benefiting more from a subsidy. The ultimate aim of subsidising fertiliser is to provide farmers with access to cheap fertilisers to incentivise usage and cultivation of high-yielding varieties. Yet because it is likely that farmers' demand for fertiliser is more sensitive to prices ¹4 than fertiliser manufacturers' supply, the larger share of economic benefits from the price subsidy probably accrue to the fertiliser manufacturer and the richer farmer who accounts for a larger share of fertiliser consumption, not the beneficiary most in need, namely the poor farmer. High minimum support for rice and wheat distort crop choice, leading to water-intensive cultivation in areas where water tables have been dropping like a stone, and ultimately induce greater price volatility in non-MSP supported crops which hurts consumers, especially poor households who have volatile incomes and lack the assets to weather economic shoc....
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....ks. High MSPs also penalise risk- taking by farmers who have ventured into non- traditional crops. At first glance, kerosene seems a good candidate for price subsidies as it is popularly conceived to be consumed mostly by the poor, and yet work done in this Survey (Chapter 3) based on NSS data show that only 59 percent of subsidised kerosene allocated via the PDS is actually consumed by households, with the remainder lost to leakage, and only 46 percent of total consumption is by poor households. Even in the case of the food distributed via the PDS, leakages are very high (about 15 percent for rice and 54 percent for wheat, with most of these leakages concentrated in the APL segment). This illustrates the importance of basing anti- poverty policy on data rather than popular perception. It also underscores the need for policymakers to acknowledge as a first-order concern the state's own constraints in implementing effective, well-targeted programs. Technology is increasingly affording better means for the government to improve the economic lives of the poor. The JAM Number Trinity- Jan Dhan Yojana, Aadhaar and Mobile numbers—might well be a game changer because it expands the....
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.... set of welfare and anti-poverty policies that the state can implement in future. These technological innovations have renewed academic interest in the potential of direct cash transfers to help the poor. Recent experimental evidence documents that unconditional cash transfers - if targeted well- can boost household consumption and asset ownership and reduce food security problems for the ultra-poor.15 Cash transfers can also augment the effectiveness of existing anti-poverty programs, like the MGNREGA. A recent study¹6 reported evidence from Andhra Pradesh where MGNREGA and social security payments were paid through Aadhaar-linked bank accounts. Households received payments faster with the new Aadhaar- linked DBT system, and leakages decreased so much that the value of the fiscal savings - due to reduced leakages – were 8 times greater than the cost of implementing the program. Much of the leakage reduction resulting from biometric identification stems from fewer ghost beneficiaries. Indeed, the government is already realizing the gains from direct benefit transfers areas by paying cooking gas subsidies directly into the bank accounts of 9.75 crore recipients. For the ag....
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....riculture sector which is currently under stress, this evidence creates possibilities. The virtue 14 One estimate suggests that farmers' demand for fertiliser falls by nearly 6.4 percent for a 10 percent increase in fertiliser prices. Dholakia, R.H. and Jagdip Majumdar, “Estimation of Price Elasticity of Fertilizer Demand in India", 2006, Working Paper. 15 Johannes Haushofer & Jeremy Shapiro, "Household Response to Income Changes: Evidence from an Unconditional Cash Transfer Program in Kenya", 2013, Working Paper. 16 Karthik Muralidharan, Paul Niehaus & Sandip Sukhtankar, “Building State Capacity: Evidence from Biometric Smartcards in India", 2014, Working Paper. Economic Outlook, Prospects, and Policy Challenges of MGNREGA, for all its deficiencies, is that it is self-targeting. If the program could lead to the creation of rural assets such as rural roads, micro- irrigation and water management infrastructure, and if leakages could be minimized through the JAM number trinity, rural India could witness both the creation of opportunity and protection of the vulnerable. Today there are about 125.5 million Jan Dhan bank accounts ¹7, 757 million Aadhaar numbers, and app....
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....roximately 904 million mobile phones¹8. It is possible to envisage that when the JAM trinity becomes linked, the goal of periodic and seamless financial transfers to bank accounts after identification through the Aadhaar number can be implemented with immeasurable benefits to helping the lives of the poor. The heady prospect for the Indian economy is that, with strong investments in state capacity, that Nirvana today seems within reach. It will be a Nirvana for two reasons—the poor will be protected and provided for; and many prices in India will be liberated to perform their role of efficiently allocating resources and boosting long-run growth. Even as it focuses on second and third generation reforms in factor markets, India will then be able to complete the basic first generation reforms. This will be the grand bargain in the political economy of Indian reforms. 1.8 GROWTH, PRIVATE AND PUBLIC INVESTMENT "The balance sheet syndrome with Indian characteristics" creates a web of difficult challenges that could hold back private investment. Private investment must remain the primary engine of long-run growth. But in the interim, to revive growth and to deepen physical conn....
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....ectivity, public investment, especially in the railways, will have an important role to play. Since the new government assumed office, a slew of economic reforms has led to a partial revival of 25 investor sentiment. Tentative signs that the worst is over are evident for example in data that shows that the rate of stalled projects has begun to decline and that the rate of their revival is inching up (Figure 1.14). But increasing capital flows are yet to translate into a durable pick-up of real investment, especially in the private sector. This owes to at least five interrelated factors that lead to what the Mid-Year Economic Analysis called the “balance sheet syndrome with Indian characteristics." First, hobbled by weak profitability and weighed down by over-indebtedness, the Indian corporate sector is limited in its ability to invest going forward (the flow challenge). One key indicator of profitability—the interest cover ratio, which if less than one implies firms' cash flows are not sufficient to pay their interest costs-has also worsened in recent years (Figure 1.15). Further, as the Figure 1.16 shows, the debt-equity ratios of the top 500 non-financial firms have ....
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....been steadily increasing, and their level now is amongst the highest in the emerging market world. Second, weak institutions relating to bankruptcy means that the over-indebtedness problem cannot be easily resolved (the stock and 'difficulty-of- exit' challenge). This is reflected in the persistence of stalled projects which have been consistently around 7 to 8 percent of GDP in the last four years. Third, even if some of these problems were solved, the PPP model at least in infrastructure will need to be re-fashioned to become more viable going forward (the institutional challenge). Fourth, since a significant portion of infrastructure was financed by the banking system, especially the public sector banks, their balance sheets have deteriorated.19 For example, the sum of non- performing and stressed assets has risen sharply, and for the PSBs they account for over 12 percent 17 Pradhan Mantri Jan-Dhan Yojana progress report (http://www.pmjdy.gov.in/account-statistics-country.aspx) 18 http://www.trai.gov.in/WriteReadData/WhatsNew/Documents/Presspercent20Release-TSD-Mar,14.pdf. 19 According to RBI's Financial Stability Report, December 2014, the contribution of mining, iron and steel....
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...., textiles, aviation and other infrastructure to total advances stands at 28 percent whereas their contribution in stressed assets is 54 percent. 26 Economic Survey 2014-15 Figure 1.14: Overview of Stalled Projects, 2011Q1 to 2014Q2 (lakh crore) 2 1.8 1.6 1.4 1.2 1 0.8 0.6 0.4 0.2 0 Q4 Q1 Q2 Q3 Q4 Q1 2010 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 2011 2012 2013 2014 Implementation-stalled during the quarter Source: CMIE. of total assets (Figure 1.17). Uncertainty about accounting and valuation, and indeed the history of banking difficulties across time and space, counsel in favor of over- rather than under- recognizing the severity of the problem. When banks' balance sheets are stressed they are less able to lend, leading to reduced credit for the private sector (the financing challenge).20 Finally, in a peculiarly Indian twist, this financing problem is aggravated by generalized risk-aversion (the challenge of inertial decision-making). For the public sector banks in particular, which are exposed to governmental accountability and oversight, lending in a situation of NPAs is not easy because of a generic problem of caution, afflicting bureaucratic decision-making. Actions being undertaken by the....
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.... government to enhance the supply of critical inputs such as coal and gas, as well as regulatory reform, will alleviate some of these constraints, especially in the public sector where the data identify them as being regulatory in character (clearances and land acquisition). Steps are being taken to address the institutional problem, by creating a better framework for PPPs and for infrastructure Implementation-stalled revived during the qaurter investment in general. The RBI is making efforts to get banks to recognize their bad loan problems, and address them. But the impact of these initiatives has so far been limited. The stock of stalled projects remains extraordinarily high; firm profitability, especially for firms working in the infrastructure sector, remains low. So, questions on the pace and strength of recovery of private sector investment remain open. If the weakness of private investment offers one negative or indirect rationale for increased public investment, there are also more affirmative rationales. India's recent PPP experience has demonstrated that given weak institutions, the private sector taking on project implementation risks involves costs (delays in land acqu....
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....isition, environmental clearances, and variability of input supplies, etc.). In some sectors, the public sector may be better placed to absorb some of these risks. Further, there continue to remain areas of infrastructure - rural roads and railways that provide basic physical connectivity- in which private investment will be under-supplied. One irony is that while financial and digital connectivity are surging ahead, basic physical connectivity appears to lag behind. 20 Suggestions on how capital markets can play a greater role in infrastructure financing are elaborated in last year's Economic Survey. 0.9 1 40% Economic Outlook, Prospects, and Policy Challenges 27 Figure 1.15: Companies with ICR≤1, 2011Q3 to 2014Q2 35% 30% 25% 20% 15% 10% 5% 0% Q3 Q4 2Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 2011 2012 2013 2014 Chronic cases (not covering interest in at least 4 quarters) Companies with ICR 10% Figure 4.6B: Debt to Equity Ratio of Indian Corporates (BSE 500) State 2013 Q4 2014 Q3 West Bengal 34.4 28.9 1 0.9 Himachal Pradesh 20.2 22.7 0.8 Odisha 11.4 0.7 19.9 0.6 Jharkhand 32.0 17.3 0.5 0.4 Uttar Pradesh 26.2 16.6 0.3 Chhattisgarh 20.2 15.4 0.2 0.1 Andhra Pradesh 12.3 14.9 Maharashtra 7.5....
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.... 12.4 2009-10 2010-11 2011-12 2012-13 2013-14 2014-15 â– Debt/Equity Debt/Equity adjusted for cash Telangana 9.0 10.0 Source: CMIE Source: Bloomberg and J.P. Morgan 72 Economic Survey 2014-15 over time and is significantly higher when viewed against other comparator countries. To some extent high levels of debt may be justified if a company has sufficient earnings to pay the interest component of outstanding debt. This ability of a company to pay the interest on its outstanding debt is measured using the Interest Coverage Ratio (ICR). ICR is technically defined as the ratio of a company's earnings before interest and taxes (EBIT) of one period to its interest expenses over the same period. An ICR below 1 therefore indicates a low EBIT relative to interest expenses and highlights serious weaknesses in the company's balance sheet. The figure 4.7 shows the percentage of companies in a large sample of 3,700 listed companies in India that have ICR 2 lakhs 10 lakhs 1990 92.2 7.8 95.8 4.2 1995 89.1 10.9 93.6 6.4 2000 78.5 21.4 91.3 8.7 2003 72.6 27.4 87.5 12.5 2005 66.7 33.4 88.1 11.9 2011 48.0 52.0 76.2 23.8 3. There has been a substantial increase in share of agricultural credit ou....
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....tstanding that emanates from urban and metropolitan areas, which is deeply puzzling. 4. There has been a concentration of disbursal of agricultural credit from January to March, which are generally not the normal periods of borrowing by farmers. This shows that in order to meet priority sector lending targets banks possibly raise their lending activity in months when farmers may not necessarily need it the most. 5. There is a sharp decrease in the share of long-term credit in total agricultural credit. Thus, the portion of agricultural credit that was used for capital formation in agriculture has become small. The number has come down from over 70 per cent in 1991-92 to about 40 per cent in 2011-12. 6. The implication of this evidence is that lending to agriculture may be excessive and going predominantly to large farmers. It is not being used for agricultural capital formation. Perhaps most significantly a large share of it may not be going to core agricultural activities at all. *Points 1 to 5 are based on the analysis of Ramakumar and Chavan (2014), “Bank Credit to Agriculture in India in the 2000s: Dissecting the Revival," Review of Agrarian Studies. 5.4 A COMPARATIVE ANA....
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....LYSIS OF BANKING AND CREDIT 5.4.1 Is India credit-addled and over-banked? India has witnessed a credit boom over the last decade, with the share of credit-GDP increasing from 35.5 percent in 2000 to 51 percent in 2013, with the bulk accounted for by bank lending. Is this unusual? We answer this question in four ways. First, we show the evolution over time in credit- GDP ratios in India and selected other countries (Figure 5.3) (as defined by the World Bank).5 The 4 See "Corporate Vulnerabilities in India and Banks' Loan Performance,†IMF Staff Working Papers (2014), and "House of Debt," Credit Suisse Research (2013). 5 The graphs uses World Bank's domestic credit to private sector, defined as financial resources provided to the private sector by financial corporations, such as through loans, purchases of non-equity securities, and trade credits and other accounts receivable, that establish a claim for repayment. 82 Economic Survey 2014-15 Figure 5.3: Domestic Credit to GDP Ratio (Time Series) India below Low Middle-Income Countries Credit/GDP(%) 250 200 150 100 50 CHN IND JPN KOR LMIC Source: World Bank Databank. Note: LMIC stands for low and middle income countries. level of....
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.... credit is lower than most countries nor has it increased more rapidly. Next we undertake a cross-country comparison plotting this same indicator against a country's level of development using the log of per capita GDP in purchasing power parity (PPP) terms as a proxy (Figure 5.4). As countries become richer, they tend on average to see a rise in credit, reflected in the upward sloping trend line. But again, India is close to the trend line, indicating that for its level of development, credit levels are reasonable. Figure 5.4: Domestic Credit to Per-capita GDP for 2013-India Placed Well Credit/GDP(%) 200 150 100 50 DAB NER MOZ TGO NPL India 5411.6 CP South Afri 12506.7 Thail... 14393.5 EAS China 11906.5 • LCA QU$A JPN NLD ESP IRC OFC GBR Malaysia KOR SWE 23338.0 âš« AUS ECS FRAAUT â—MOS UV Chile 21911.3 DEU LMMIC MARUK Brazil 150375 Turkey 19020.1 TSV NOC BHR CZE Indonesia AGO 61.116463.4 Mexico KAZ TTO SYC ODZA IRABY GNQ IRQ 9 9.5 10 10.5 11 Philippines 6535.9 PANGAG â¤AFED 0 Ghana 3992.1 6.5 7 7.5 8 8.5 Log (GDP per capita in PPP terms) Source: World Bank Data 6 Note that the trend line drawn for the entire set of 176 countries in the World Bank data set. Credi....
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....t, Structure and Double Financial Repression: A Diagnosis of the Banking Sector Figure 5.5: Banking Credit as a Fraction of Total Credit for 2014 Banking credit to firms + households as a fraction of total credit (%) 110% 100% MYS IND ZAPRA 90% JDN TUR GRC 80% 70% 60% 50% 40% 30% 20% 8.5 9 9.5 CHN SAU SGP HKFTE RUS ITA ESP POLPRT KORPN AUS MEX CZE FRA AUT EMU GBR FINCAWE NLD HUN 10 10.5 IRL USA NOR BEL 11 LUX 11.5 Log (GDP per capita in PPP terms) Source Bank of International Settlements Next we ask whether India is over-banked. In Figure 5.5 we plot the share in total credit in the economy that is accounted for by banks against a country's level of development. The trend line is downward sloping suggesting that banking should shrink in size over the course of development relative to other sources of funding such as capital markets. Here too, India is well placed, in fact it is below the trend line. India is neither over-banked nor are capital markets too small at this stage of development. That will have to change over time and the policy conditions should facilitate that transition but for the moment India is not an outlier. Finally, it is worth asking, whether the Indian banking....
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.... and financial system has been especially irresponsible and imprudent in the growth phase. Figure 5.6: Domestic Credit to GDP Since Take-off-India placed well Credit as a % of GDP 250 200 150 100 50 0 5 10 15 20 25 30 35 40 45 50 Brazil China Time from take off in years India Japan Korea Source: World Bank Databank Notes Years of takeoff. Brazil, Japan and Korea: 1961, China: 1978, India: 1979. 7 As defined by the Bank of International Settlements, this consists of “credit to non-financial corporations (both private-owned and public-owned), households and non-profit institutions serving households as defined in the System of National Accounts 2008." 83 84 Economic Survey 2014-15 Figure 5.7A: Ratio to total deposits (fraction) 0.90 0.80 0.70 0.60 0.50 0.40 0.30 0.20 0.10 0 Public Sector Banks Figure 5.7B: Ratio to total advances (fraction) 0.90 0.80 0.70 0.60 0.50 0.40 0.30 0.20 0.10 0 Private Banks Foreign Banks Public Sector Banks Private Banks Foreign Banks Source: RBI To answer this, we plot the evolution of credit- GDP in take-off time (Figure 5.6). For each country, the starting point is when its growth started to accelerate. The chart shows that India's credit bubble wa....
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....s not worse than the experience of countries during comparable times. Other countries such as Japan and China saw faster credit growth during boom years. Thus, even in the last phase of rapid credit growth during the 2000s, the Indian financial system was no more irrationally exuberant than those around the world. This evidence leads naturally to the question of what then is the problem on the structural side. 5.4.2 Is there adequate competition? A primary concern of the health of the banking sector in India has been lack of sufficient internal competition. Private banks have slowly been brought into the arena since 1990. It is important to note that India's approach was not privatisation of public sector banks, rather it was based on allowing entry of new private banks. This strategy worked reasonably well in the telecommunication and civil aviation sectors but did it work in banking? The results have been mixed. Figure 5.7 A and B show that India saw a steady rise in the size of private sector banks till 2007 both in relation to deposit and lending indicators. Thereafter, the process slowed considerably (and of course in the aftermath of the Lehman crisis, there was a flight to s....
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....afety toward the PSBs). So, one of the paradoxes of recent banking history is that the share of the private sector in overall banking aggregates barely increased at a time when the country witnessed its most rapid growth and one that was fuelled by the private sector. It was a case of private sector led growth without private sector bank financing. Even allowing for the irrational exuberance of the PSBs that financed Return on Assets (%) Credit, Structure and Double Financial Repression: A Diagnosis of the Banking Sector 85 this growth phase, the reticence of the private sector was striking. The question of competition extends to other sources of funding as well. Figure 5.5 suggested that India's size of the banking is not too large relative to the level of development, suggesting that that level of competition from capital markets is line with a cross country comparison. Of course, over time, if India grows at 8 percent a year for the next twenty years, a rapid shift in the composition of India's financial sector away from banking is desirable. This shift will encourage transparency and better pricing of corporate risk. Figure 5.8A: Banking Indicators: CRAR 18 5.5 Are Public Sect....
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....or Banks uniform in performance? How much variation in performance exists within the public sector banks and between the public sector and private sector banks? To answer this questions, Figure 5.8 plots the time series of four key banking indicators for public and private sectors banks-CRAR, Leverage Ratio, Return on Assets and Non-performing + Restructured Assets.³ In addition to the weighted average numbers, the figure also plots a 95 per cent confidence interval for the public sector banks (the upper line refers to the upper confidence bound and the lower line refers to the lower confidence bound). Note that Figure 5.8B: Banking Indicators: Leverage Ratio CRAR (%) 6 42 16 14 12 10 Leverge Ratio (%) 3 8 6 1 QI QI QI QI QI QI QI QI 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2014 ΟΙ QI QI QI QI QI Q3 Public Sector Banks www.upper bound (PSB) Private Sector Banks lower bound (PSB) 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2014 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q3 Public Sector Banks upper bound (PSB) Private Sector Banks lower bound (PSB) Figure 5.8C: Banking Indicators: Return on Assets Figure 5.8D: Banking I....
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....ndicators: NPAs + Restructured Advances 2 1.5 1 0.5 0 -0.5 Q1 -1 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2014 QI QI Q1 Q1 ΟΙ ΟΙ ΟΙ ΟΙ ΟΙ QI QI QI Q1 Q3 Public Sector Banks Private Sector Banks -------* upper bound (PSB) lower bound (PSB) NPAS + Restructured Advances of Total (%) 0 25 20 15 10 5 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2014 Q1 Q1 Q1 QI QI QI QI Q1 QI QI Q1 QI Q1 Q3 Public Sector Banks wwwwwwwww upper bound (PSB) Private Sector Banks lower bound (PSB) 8 Capital to risk weighted assets ratio (CRAR) is arrived at by dividing the capital of the bank with aggregated risk weighted assets for credit risk, market risk and operational risk. Leverage ratio is defined by the RBI as ratio of total assets to total capital. The international definition, for example as laid out by the Bank of International Settlements, is typically the inverse. For the purpose of this chapter we will use the international definition. Return on Assets (ROA) is a profitability ratio which indicates the net profit (net income) generated on total assets. It is computed by dividing net income by average total asset....
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....s. Non-Performing Asset: An asset, including a leased asset, becomes non-performing when it ceases to generate income for the bank. Restructured Asset: A restructured account is one where the bank, grants to the borrower concessions that the bank would not otherwise consider. 86 Economic Survey 2014-15 except for NPAs, the higher the number, the better the indicator value. The figures show that there is a lot of variation within the public sector banks. In numerical terms, the leverage ratio for the best bank is about 1.7 times more than for the worst, and the Gross NPAs plus restructured assets are 4 times more for the worst bank than the best. Box 5.3: Leverage Ratio It is also important to note that the best amongst the public sector banks are often performing less than the private sector average, although this fact should be seen against the greater social obligations imposed on the PSBs. There are two other key things to notice in Figure 5.8. First, the variation in the Leverage Ratio is One of the legacies of the Great Recession (2008-2013) in the West has been active soul searching for adequate measures of risk and safe capital in the banking system. Almost all stress tests ....
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....formerly were based on ratio of a risk weighted measure of capital to the total assets. In India this avatar, called CRAR- Capital to Risk (Weighted) Assets Ratio, has been the dominant measure of capital adequacy for bank stability in policy and popular discourse. There is however growing international discontent with the measure because it failed to capture risk appetite before the financial crises in the US and in Europe. For this reason the focus is shifting to giving more weight to the Leverage Ratio. Defined by the Reserve Bank of India as the ratio of total assets to total capital, the international definition, for example as laid out by the Bank of International Sentiments, is typically the inverse. We will use the international definition. A study by prominent economists, Pagano et all (2014), on the European banks states ‘While large banks' leverage ratios fell between 2000 and 2007, the regulatory ratio – Tier 1 capital to risk-weighted assets - remained relatively stable. The median Tier 1 capital ratio was around 8 per cent in each year between 1997 and 2007 – a period over which the median leverage ratio fell by half. These insights reflect increas....
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....ing divergence between book and regulatory measures of leverage. These two measures were highly correlated in the 1990s, as one would expect. But the correlation between them broke down in the early 2000s for the largest banks. By 2012, the correlation had turned strongly negative. Remarkably, a negative correlation implies that banks that were more capitalised according to the regulator had lower equity-to-asset ratios." Why did this happen? Simple arithmetic implies that the ratio of total assets to risk weighted assets diverged over time. The risk weights were no longer doing their job! Figure below plots the time series of the correlation of the two indicators- CRAR and Leverage Ratio for Europe and India. In Europe, the correlation has steadily gone south over the last decade with alarmingly negative numbers for the last few years. For the public sector banks in India the correlation of the average of last three years of CRAR and Leverage Ratio stands at 0.45, which is good but definitely not great. In fact as the figure shows the correlation dipped to less than 0.1 in 2010. Figure: Correlation Between CRAR-Leverage Ratio for Indian PSBs (lhs) & Europe (rhs) Correlation 10- 08....
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....- 06- 04- 02- 1.0 Biggest 20 listed banks ■■■Other listed banks 0.8 0.6 0.4 0.2 0.0 -0.2 -0.4 -0.6 -0.8 ||||||||| 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 1998 2000 2002 2004 2006 2008 2010 2012 Source: RBI, Bloomberg and Pagano et all (2014)ª 9 The upper and lower lines represent the second or third best and worst banks, respectively for CRAR, Leverage Ratio, Return on Assets, and the reverse for NPAs. Credit, Structure and Double Financial Repression: A Diagnosis of the Banking Sector 87 Figure: Scatter Plot of Leverage Ratio and CRAR (3 year averages, 2012-2014) for PSBs Leverage Ratio 8 7.5 7 6.5 5.5 10 5 4.5 4 11 11.5 12 12.5 13 13.5 CRAR a Source: RBI The next Figure below shows a scatter plot for the last three year average of CRAR and Leverage Ratio for all public sector banks in India. As can be seen the trend-line is positively sloped which is good news. However, there are some worrying outliers that must be examined imminently. The scatter plot Figure also shows the average of Leverage Ratios for public sector banks varies from 7.8 to 4.5. Admati and Hellwig in a new book called “Bankers New Clothes" argue that at ....
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....3 per cent the bank will go bankrupt if its assets loose more than 3 per cent in value. Banks themselves would never grant loan to a firm that only had only 3 per cent effective equity.b They propose a much higher leverage ratio in excess of 10, even 15 per cent. It is important to note that if a bank has a moderate-low leverage ratio, and excellent return on assets and negligible NPAs, the leverage ratio is less of a concern. But, this changes dramatically when there is a substantial quantity of toxic loans on its books. There are at least two reasons why we should focus on the leverage ratio in India. First, as the European and indeed Indian experience shows, the CRAR can be a very poor indicator of stability, especially in adverse situations when risk weights loose meaning and value. More important, given weak governance systems within banks and the difficulty of regulating them from the outside, it is difficult to know how the risk weights are being assigned. This becomes more important because of the size of stressed assets. In other words, today with weak institutions and sizable stressed assets, there is an even greater premium on transparency in India which a leverage ratio....
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.... provides. Indian regulators and policymakers should therefore elevate the role of the leverage ratio in financial stability and soundness assessments. Pagano M, V Acharya, A Boot, M Brunnermeier, C Buch, M Helwig, S Langfield, A Sapir, and L van den Burg (2014), Is Europe Overbanked? Report of the Advisory Scientific Committee, European Systemic Risk Board, June. b Admati, Anat, and Martin Hellwig. 2013. The Bankers' New Clothes: What's Wrong with Banking and What to Do about It. Princetion University Press. 88 Economic Survey 2014-15 much more than in CRAR. And, second the return on assets has declined and stressed assets loans have increased to worrying levels with substantial variation across banks. On the former, Box 5.3 presents the case, especially strong for India, for using the leverage ratios to measure, test, and monitor financial stability almost as much as, if not more than, the CRAR ratio. 5.6 Policy Implications To summarize, we propose the 4Ds of policy going forward- deregulate, differentiate, diversify and disinter. â—† Deregulate: As the banking sector exits the financial repression on the liability side, aided by the fall in inflation, this is a perfect opp....
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....ortunity to relax asset-side repression. First, as described in Box 5.1, SLR requirements can be gradually relaxed. This will provide liquidity to the banks, depth to the government bond market, and encourage the development of the corporate bond market. The right sequence would be to gradually reduce SLR and then provide incentives for a deeper bond market. Second, PSL norms can be re-assessed. There are two options: one is indirect reform, bringing more sectors into the ambit of the PSL, until in the limit every sector is a priority sector; the other is to redefine the norms to slowly make priority sector more targeted, smaller, and need-driven. The dual responsibility of building a modern economy and lifting the standard of living at the lowest percentiles of income demand creativity, including more evidence-based policy making especially in relation to PSL. ♦ Differentiate within PSBs: The analysis in this chapter suggests that there is sufficient variation in the performance of public sector banks. The policy implication is that a one- size-fits-all approaches to governance reforms, public ownership, exit and recapitalisation should cede to a more selective approach. â....
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....¦ Diversify within and outside the banking system: More banks and more kinds of banks must be encouraged. Healthy competition from capital markets is essential too which will require policy support which was discussed extensively in last year's Economic Survey. â—† Disinter: Better bankruptcy procedures for the future is essential. Debt Recovery Tribunals are over-burdened and under- resourced, leading to tardy turnaround times and delayed justice. The ownership structure of Asset Restructuring Companies in which banks themselves have significant stakes creates misaligned incentives. The SARFAESI act seems to work more against the smallest borrowers and medium sector enterprises. Distressed assets hang like a Damocles sword over the economy and require creative solution. One possibility is the appointment of an Independent Renegotiation Commission with political authority and reputational integrity to resolve some of the big and difficult cases. When the next boom and bust comes around, India needs to be better prepared to distribute pain between promoters, creditors, consumers, and taxpayers. Being prepared for the clean- up is as important as the being prudent in the run-....
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....up. Putting Public Investment on Track: 06 The Rail Route to Higher Growth CHAPTER "the introduction of the railways has been historically the most powerful single initiator of take-offs" - W. W. Rostow¹ 6.1 INTRODUCTION Since the new government assumed office, a slew of economic reforms has led to a partial revival of investor sentiment. But increasing financial flows are yet to translate into a durable pick-up of real investment, especially in the private sector. This owes to a number of interrelated factors that stem from what has been identified as the "balance sheet syndrome with Indian characteristics." If the weakness of private investment offers one negative or indirect rationale for increased public investment, there are also more affirmative rationales that are elucidated in chapter 1. As emphasized in the Mid Year Economic Analysis 2014-15 there is merit in considering the case for reviving targeted public investment as a key engine of growth in the short run- not to substitute for private investment- but to complement and indeed to crowd it in. This chapter starts off with simple facts to demonstrate that an increase in public investment would not crowd out private i....
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....nvestments in India under in the present circumstances, and then goes on to build the case for targeting public investment to the sector where it can generate the largest 1 spillovers- which could well be the Indian Railways. 6.2 EFFECTS OF INCREASING PUBLIC INVESTMENT ON OVERALL OUTPUT AND PRIVATE INVESTMENTS The decline in public as well as private corporate investment has been associated with the growth decline in recent years. Data based on the older series of the Central Statistics Office (CSO) indicates that a boom in private corporate investment in the high growth phase (2004-05 to 2007-08) was accompanied by an increase in public investment by about 1.5 percentage points. A decline in public investment by more than 1 percentage point between 2007-08 and 2012- 13, is accompanied by a general decline in private corporate investment by more than 8 percentage points (barring an increase during 2009-10 and 2010-11) (Figure 6.1). The International Monetary Fund (IMF), in the World Economic Outlook (October 2014)², has noted that increases in public infrastructure investment, if efficiently implemented, affects the economy in two ways. In the short run it boosts aggregate deman....
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....d and crowds in private investment due to the complementary nature of infrastructure services. In the long run, a supply side effect also kicks in as the infrastructure built Rostow, W. W. "The process of Economic Growth", Oxford, Clarendon Press, 2d ed., 1960, pp. 302-3 cited in Mitchell, B. R. "The Coming of the Railway and United Kingdom Economic Growth", The Journal of Economic History, 24(3), September 1964. 2 IMF, "Is it Time for an Infrastructure Push? The Macroeconomic Effects of Public Investmentâ€, World Economic Outlook, Chapter 3, October 2014. 0 5 10 20 20 25 15 Ж 30 35 90 Economic Survey 2014-15 Figure 6.1: Gross Capital Formation by Sectors as a ratio of GDP, 1990-91 to 2012-13 40 - * Ж 1990-91 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 ежеж 3 gross capital formation household sector Source: Central Statistics Office. public sector private sector feeds into the productive capacity of the economy. Econometric exercises reported by the IMF confirm that public investment increases can have positive effects on out....
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....put. The medium term public investment multiplier for developing economies is estimated to be between 0.5 and 0.9 - a little lower than that estimated for advanced economies. However, the magnitudes depend on the efficiency of implementation. Indeed, the two biggest challenges facing increased public investment in India are financial resources and implementation capacity. The former is addressed in Chapter 5 in this volume. As regards the latter, the trick is to find sectors with maximum positive spillovers and institutions with a modicum of proven capacity for investing quickly and efficiently. Two prime candidates are rural roads and railways. The impetus to roads was imparted by the previous NDA government under the then Prime Minister Atal Bihari Vajpayee [The National private corporate sector Highways Development Project (NHDP) and the Pradhan Mantri Gram Sadak Yojana (PMGSY)] and the evidence suggests that the payoffs, especially with regard to rural employment, were large in villages that were not already connected to the road network³. The present government can now do for the neglected railways sector what the previous NDA government did for rural roads. This impetus ha....
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....s the potential to crowd in greater private investment and do so without jeopardizing India's public debt dynamics. What does existing empirical evidence say about the influence of public investment on growth in India? Rodrik and Subramanian (2005)4 while analysing India's productivity surge around 1980 acknowledge a possible productivity boosting role of public infrastructure investments (in contrast to the demand creating effects). They analyse the effects on overall growth using a framework Asher, Sam & Paul Novosad, “The Employment Effects of Road Construction in Rural Indiaâ€, 2014, Working Paper accessed at http://www.nuffield.ox.ac.uk/users/Asher/research.html. 4 Rodrik, D. & A. Subramanian, “From "Hindu Growth" to Productivity Surge: The Mystery of the Indian Growth Transition" 2005, IMF Staff Papers, 52(2). Putting Public Investment on Track: The Rail Route to Higher Growth developed by Robert Barro ("Government Spending in a Simple Model of Endogenous Growth", 1990, Journal of Political Economy, 98(5)) where government infrastructure services are an input into private production. Their results indicate that allowing for the appropriate lag (around five ye....
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....ars) between public infrastructure spending and growth, the former can explain around 1.5-2.9 percent of overall growth. A Study by the Reserve Bank of India (RBI) reports the long run multiplier (of capital outlays on GDP) to be 2.45. The study also confirms that the effect of revenue expenditure on GDP, though high, fades out after the first year, suggesting gains from re- prioritizing expenditures. 6.3 THE CASE FOR PUBLIC INVESTMENT IN RAILWAYS 6.3.1 Why railways? Under investment and Lack of Capacity Addition Conceptually, there is a strong case for channeling resources to transport infrastructure in India given the widely known spillover effects of transport networks to link markets, reduce a variety of costs, boost agglomeration economies, and improve the competitiveness of the economy, especially Figure 6.2A: Resource Allocation in Transport Sector and Railways (Per cent) 20 91 manufacturing which tends to be logistics-intensive. However, resources need to be prioritized among sectors based on assessments of risks, rewards, and capacity for efficient implementation. The first railway lines in India were built in the 1850s and after by private British companies who were guara....
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....nteed, by the colonial government, a return of 5 percent on their capital investment. The establishment of railways led to integration of markets and boosted incomes. Today the 'lifeline of the nation' operates over 19,000 trains carrying 23 million passengers and over 3 million tonnes of freight per day while employing over 13 lakh people. In contrast to sectors such as civil aviation, the two major land transport sectors- roads and especially railways- are dependent on public investments. While all public investment in the railways is undertaken by the central government, public investment in roads is undertaken by the central government as well as state governments. How much resources have flowed to railways over the years? Successive plans have allocated less resources to the railways compared to the transport sector as Figure 6.2A shows. The legacy of inadequate allocation is reflected in the fact that Figure 6.2B: Share of Railways and Roads in Total Developmental Expenditure* (Per cent), 1990-91 to 2013-14 15 10 10 6 Up to 5th Plan 6th Plan 7th Plan 8th Plan 9th Plan 10th Plan 11th Plan 12th Plan Railways as percentage of total plan 1990-91 2000-01 2005-06 2006-07 2007-08 20....
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....08-09 2009-10 2010-11 2011-12 2012-13 2013-14 â– Railways â– Roads and bridges â– Transport sector as percentage of total plan Source: Indian Public Finance Statistics, Ministry of Finance.*; Includes both Centre and States. 5 Reserve Bank of India, “Fiscal Multipliers in India" Box II.16, Annual Report 2011-12. 6 Bogart, Dan & Latika Chaudhary, "Could railways have done more to aid economic development in India?", May 2013, accessed at http://www.ideasforindia.in/article.aspx?article_id=142. Expert Group on Indian Railways, "The Indian Railways Report - 2001: Policy Imperatives for Reinvention and Growthâ€. New Delhi. NCAER 2001. 7 Bogart, Dan & Latika Chaudhary, “Railways in Colonial India: An Economic Achievement?", May 2012, accessed at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2073256. 92 Economic Survey 2014-15 the share of railways in total plan outlay is currently only 5.5 per cent vis-à -vis about 11 per cent for the other transport sectors and its share in overall development expenditure has remained low at below 2 percent over the past decade (Figure 6.2B). That these numbers are low is indicated by a comparison with China. In abso....
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....lute terms and as a share of GDP, Chinese investment in railways dwarfs that in India. As a share of GDP, China has invested around three times as much as India on average over the period 2005-2012 (Figure 6.3). In per-capita terms, China has invested on average eleven times as much over the same period even though both countries have similar populations. Even allowing for China's size, these numbers are telling. Figure 6.3: Investment in Railways-India and China (Per cent of GDP), 2005 to 2012 2.5 2 1.5 0.5 1 0 2005 2006 2007 2008 2009 2010 2011 2012 Public Investment in India Capital Investment in China Source: World Bank and MoF calculations. Figure 6.4: Addition to Capacity (route kilometres, '000), 1990 to 2010 95 85 75 65 55 55 China India 1990 1995 2000 2005 2010 Source: World Bank. 8 It is important to note that a significant portion of investment in the Chinese Railways is via joint ventures of the government with provincial authorities and, for some freight railways, major users such as coal mines are also a party. A part of the freight tariff is earmarked as a Railway Construction Fund (RCF) which is used only for infrastructure capital spending. This eases strain on the....
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.... budget and facilitates capacity creation. Since the Chinese Railways has been corporatized, it is also allowed to issue debt and borrow from the market to meet funding requirements. Putting Public Investment on Track: The Rail Route to Higher Growth 93 What have been the consequences of such underinvestment for the Indian Railways? The first casualty has been capacity expansion. Figure 6.4 indicates that in 1990 the Chinese rail network of about 57,900 route kilometers lagged behind India's 62,211 route kilometers. By 2010, the situation was reversed in favour of China with the country's network expanding to over 90,000 route kilometers while India's grew marginally to 64000 route kilometers. With lack of capacity addition, the share of railways in the GDP has declined to stand at around 1 per cent in recent years. As figure 6.5 shows, track expansion in the Indian railways (as measured by an index of running track kilometers over the period 1991 to 2012 with base 1991) has miserably lagged behind capacity addition in the domestic roads sector (measured by an index of length of roads in kilometers inclusive of national and state highways, urban and rural roads). This has effective....
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....ly led to railways ceding significant share in passenger and especially freight traffic to the road sector. The Total Transport System Study on Traffic Flows & Modal Costs (Highways, Railways, Airways & Coastal Shipping) by RITES Ltd. had estimated that the share of the railways in originating tonnage has fallen from 65 per cent in the late 1970s to 30 per cent in 2007-08. McKinsey's Building India: Transforming the Nations' Logistic Infrastructure (2010) study has estimated that the modal share in freight traffic stands at 36 per cent for the railways vis-Ã -vis 57 per cent for roads. According to the Report of the National Transport Development Policy Committee (NTDPC, 2014) this share is estimated to decline further to 33 per cent in 2011-12. The share of railways in freight traffic in some other countries as of 2011 is reported in figure 6.6. The cross-country numbers need to be interpreted with care. For example, the US has a 44 per cent share despite having extensive networks of coastal shipping links and elaborate inland waterways that carry significant freight (Amos, 2011). According to the McKinsey Study (2010) continuation of the current state of affairs in India would ....
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....imply the share of railways in freight traffic declining further to 25 percent by 2020. As Amos Figure 6.5: Indian Railways; The Road Less Traveled (1991=100) 240 190 140 90 @ 8 8 8 r r r X @ 8 x 8 x x x x x x Source: CEIC database. roadindex railindex ÐИ 94 Economic Survey 2014-15 Figure 6.6: Modal Share of Railways in Domestic Freight (Per cent) India* US Russia China Canada Australia 0 10 33 20 30 40 44 44 51 50 60 65 55 66 70 Source: Amos, Paul “Freight Railways Governance, Organization and Management: An International Round-upâ€, July 2011, World Bank Paper submitted to NTDPC (2014). *Data for India is an estimate for 2011-12 reported in the Report of the NTDPC (2014). (2011) observed “International experience is unequivocal. The more efficiently that freight railways are managed, the greater will be their role in the markets they serve, the fuller will be their contribution to economic development and the higher will be their external benefits." An efficient rail freight network can help industry to transport raw materials at lower costs and also with associated lower green house gas emissions, comparatively better energy efficiency, and reduced congest....
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....ion. As compared to road, railways consume 75 to 90 per cent less energy for freight and 5 to 21 per cent less energy for passenger traffic and, typically, the unit cost of rail transport for freight was lower vis-Ã -vis road transport by about Rs. 2 per net tonne-kilometer (NTKM) and for passenger by * 1.6 per passenger-kilometre (PKM) (in the base year 2000)â¹. Consequently just as the previous NDA government transformed the Indian road sector through initiation of the NHDP and PMGSY, the current need is for a bold accelerated programme 9 Report of the NTDPC (2014), Table 1.4, p.6. of investment in dedicated freight corridors (DFCs) that can parallel the golden quadrilateral, along with associated industrial corridors. Such an initiative will transform Indian manufacturing industry with "Make in India" becoming a reality. With the separation of freight traffic passenger trains can then be speeded up substantially with marginal investments. 6.3.2 Congestion A second and related consequence has been congestion and stretching of capacity. The increasing load on railway infrastructure and lower speeds are a logical consequence of lack of capacity addition. For example, the spee....
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....d of the average freight train has remained virtually constant between 2000-01 and 2012-13 at around 24-25 km/hour. In contrast, in China, the maximum speed of freight trains was 80 km/h around 2008-09, and the maximum train speed that was around 80 - 100 km/h in 1991 was raised in stages to 160 and 200 km/h on the most popular passenger corridors by 200810 and is above 300 km/h at present. 10 World Bank, "Tracks from the Past, Transport for the Future: China's Railway Industry 1990-2008 and its Future Plans and Possibilities" China Country Office, Beijing, May 2009. Putting Public Investment on Track: The Rail Route to Higher Growth 95 Figure 6.7: Benchmarking Efficiency: India vis-a-vis China and Russia 4.31 China 5.52 Russia 21.87 2.73 India 9.39 0 10 20 30 Wagon Productivity (Annual) â– Network Productivity 39.66 40 50 How congested are the Indian Railways vis-Ã -vis the two other comparable countries-China and Russia? Given that the Chinese Railways also faces congestion and has embarked on huge capacity expansion, network productivity (as measured by NTKM (million)/network length) turns out to be much greater in China vis-Ã -vis both Russia and India. Wagon productivi....
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....ty (as measured by NTKM (million)/wagon holding) is the lowest in India among the three (Figure 6.7). The same track network is shared by both passenger and freight trains in India. The extent of congestion can be gauged from map 6.1 below where the black lines represent the rail network and grey lines indicate those that are operating at above 100 percent capacity. Congestion exists irrespective of the railways network being thick or thin. On high density network (HDN) routes, over 65 per cent of total sections (161 out of 247) are running at a capacity of 100 percent or above¹¹. This percentage is higher for specific zones. For example, in the north central railways 96 percent of sections and in the south eastern railway about 75 percent of sections are operating at above full capacity. The NTDPC (2014) report argues that capacity utilisation of 80 per cent is the optimum 11 Source: Ministry of Railways data. 12 Report of the NTDPC (2014), p. 40. as some slack in line capacity is necessary to absorb and recover from unforeseen disruptions in operations of trains. With passenger trains utilizing around 65 percent of the network capacity, the above situation imposes constrain....
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....ts on the running of heavy freight trains (that hampers the ability of the railways to carry bulk commodities from mines to power and steel plants) and high speed passenger trains ¹²as passenger traffic is generally accorded priority. Over these years, data indicates that the load carried and distance travelled by a wagon per day and the turnaround time has almost stagnated. The preceding paragraphs provide an overview of the ‘route to nowhere' that the Indian Railways find themselves in: underinvestment resulting in lack of capacity addition and congestion; below- potential contribution to economic growth; neglect of commercial objectives, poor service provision, and consequent financial weakness (to which we revert later). Greater public investments, once utilized efficiently, can help the railways to overcome some of these problems. But even if it received an investment boost what would be the economy-wide impact? 96 Economic Survey 2014-15 Map 6.1 Capacity Utilization in Indian Railways* AMATAN SEA KASHIP LANCA RAILWAY MAP OF INDIA (POSITION AS ON 31-03-2013) LINE CAPACITY AND UTILISATION ABOVE 100% BANGLADESH BAY OF BENCAL ** RUPMA ANDWAN Source: Ministry of Railwa....
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....ys. * Grey lines indicate capacity utilization above 100 percent. 6.3.3 How much boost can vibrant railways provide to the economy? i. Forward and Backward Linkages of the Railways former measures the effect on other sectors that provide inputs consequent upon a big push for railways. The latter measures the effects of the big push on other sectors that use railways as an input. The input output tables published by the CSO provide data on the value of output of a sector that is used by other sectors as input for their production as well as for consumption purposes. Backward and forward linkages can be calculated from this data¹³. Transport, and especially railways infrastructure, are critical for manufacturing and services. How much impetus would the fiscal boost provided to the railways generate for the economy? One way to estimate this is to draw upon Albert Hirschman's idea of backward and forward linkages. The 13 To capture backward and forward linkages, it is important to capture direct as well as indirect linkages. For this, the inverse of the input-output matrix (Leontief inverse) needs to be calculated. The inverse matrix shows the value of input (direct and indirect ....
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....both) required to produce 1 unit of output of any sector. Increasing the output of railway service by Re 1 would not only increase the demand for output from other industries that are used as inputs by the railways, but also increase the input available for other sectors that use railway services for production. To find the backward linkage of railways, sum of value of output used from all input sectors is calculated (column sum of the matrix) and to find the forward linkage of railways, sum of value of output of railways used as an input by all other sectors is calculated. The methodology is outlined in: Guo, J & A. Planting "Using Input-Output Analysis to Measure US Economic Structural Change Over a 24 Year Period", 2000 accessed at http://www.bea.gov/papers/pdf/strucv7all.pdf. Putting Public Investment on Track: The Rail Route to Higher Growth 97 Railways are found to posses strong backward linkages (demand pull from other sectors) with manufacturing and services (Table 6.1). Based on 2007-08 data (the latest year for which the input- output tables are available), it appears that increasing the railway output by Rs. 1 would increase output in the economy by *3.3. This large mult....
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....iplier has been increasing over time, and the effect is greatest on the manufacturing sector. Investing in Railways could thus be good for "Make in India.†Further, there are sectors where railway services are an input to production (forward linkages). A Rs. 1 push in railways will increase the output of other sectors by about 2.5. This forward linkage effect has declined over time but this is largely endogenous to capacity constraints in the railways sector which has led to reliance on other modes of transport. Combining forward and backward linkage effects suggests a very large multiplier (over 5) of investments in Railways. ii. Effects of public investment in railways on overall output and private investment: An econometric analysis We can supplement the backward-forward linkage estimates with more formal econometric analysis which we show in figure 6.8. The impulse responses from the vector error-correction model (VECM) 14 indicate that increases in railway investment have positive and durable effects on levels of manufacturing and aggregate output. They confirm the results derived from the input-output tables. The figure shows that an unanticipated shock to public invest....
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....ment in railways has a strong positive effect on both manufacturing and aggregate output and the effects are permanent. In order to convert the statistical representation in figure 6.8 to a standard interpretation of a multiplier, (i.e. the unit change in manufacturing and aggregate output for a unit change in public investment in railways) we follow the procedure outlined in Ramey¹5 (2008). Table 6.1 : Railways; Backward and Forward Linkages Sector 1993-94 1998-99 2003-04 2007-08 Backward Linkage AGRICULTURE 0.01 0.01 0.01 0.02 INDUSTRY 0.63 0.76 0.93 2.04 SERVICES 1.28 1.32 1.24 1.23 Total Backward Linkage 1.92 2.08 2.19 3.29 Forward Linkage AGRICULTURE 0.13 0.12 0.16 0.07 INDUSTRY 2.15 2.03 2.11 1.18 SERVICES 1.13 1.13 1.16 1.19 Total Forward Linkage 3.41 3.28 3.44 2.45 Source: Calculations based on CSO input-output tables. 14 15 Typically for such analyses a vector auto-regression (VAR) model is used to assess the impact of a shock to one variable on the others. We use a variant of this, the vector error-correction model (VECM), as the data on public investment in railways as well as manufacturing and aggregate output are non-stationary in levels. These variables are, howeve....
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....r, co-integrated and we are interested in their relationships both over the short as well as the long run. Ramey, Valerie A., "Identifying Government Spending Shocks: It's All in the Timing", 2009, National Bureau of Economic Research. http://www.nber.org/papers/w15464. In order to convert the 1 standard deviation (s.d.) shock to public investment in the railways to a standard multiplier we divide the elasticity coefficient (obtained from VECM) by the average ratio of railway public investments to manufacturing and aggregate output. 98 Economic Survey 2014-15 Figure 6.8: Impact of Railway Investment on Output .02 Impulse - Railways Investment, Response GDP at factor cost Impulse Railways Investment, Response - Manufacturing Output .015 .01 .005 0 0 5 10 0 Years 10 Years Table 6.2: Railway Public Investment: Output Multipliers Cholesky Impulse-Response (1-S.D.) Rescaled Multipliers Manufacturing Output Aggregate Output Manufacturing Output Aggregate Output 0 0.00 0.01 0.04 0.94 1 0.01 0.01 0.17 1.05 2 0.01 0.01 0.40 2.56 0.02 0.02 0.58 2.80 456 0.02 0.02 0.60 3.58 5 0.02 0.02 0.53 3.27 0.02 0.02 0.47 3.71 7 0.02 0.02 0.48 3.70 8 0.02 0.02 0.53 4.04 9 0.02 0.02 0.54 3.86 10 0.02 0.02....
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.... 0.50 3.76 Table 6.2 above underlines the large positive multiplier effect of railways. For instance, a Rs. 1 increase in railway investment has a cumulative multiplier effect of Rs.7.4 and 1.2 on aggregate and manufacturing output respectively, within three years of investment. This effect intensifies over the subsequent years. Taking the econometric results and those from the I-O analysis together, it seems safe to infer that the railways multiplier effect is around 5 or more: that is a Rs. 1 increase in railways investment would increase economy-wide output by 5 rupees. These numbers are consistent with results of the linkages analysis. 6.3.4 Price Distortions Ultimately, the railways has to be a viable commercial organization that is less dependent on state support and able to generate enough resources on its own to not only provide world- class passenger amenities but also by providing freight services at reasonable rates. In the long- run, state support should be largely restricted to the universal service obligations that the railways fulfill. Passenger tariffs have registered negligible increases over the past several years as indicated by a persistent larger gap between th....
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....e index of consumer prices and that of passenger rates (Figure 6.9A). In contrast, the freight rate index tracks the wholesale price index more closely (Figure 6.9B). The profits generated via freight services have cross-subsidized passenger services and Indian (PPP adjusted) freight rates remain among the highest in the world as indicated in table 6.3. 250 200 150 100 50 0 585 1993-94 1995-96 1996-97 1997-98 300 450 400 350 300 250 200 150 100 50 0 Putting Public Investment on Track: The Rail Route to Higher Growth Figure 6.9A: Index of Consumer Prices and Passenger Rates (1993-94 = = 100) 1993-94 1994-95 1995-96 1996-97 1997-98 1998-99 1999-00 2000-01 2001-02 2002-03 Figure 6.9B: Index of Wholesale Prices and Freight Rates (1993-94 = 100) 350 2000-01 2001-02 2002-03 Freight Rate Index 2004-05 2005-06 2006-07 2007-08 2008-09 WPI Passenger Rate Index 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 2010-11 2009-10 2010-11 2011-12 2012-13 2013-14 Table 6.3 : Passenger and Freight Yields in some Major Economies Country India China Russia Passenger Service Yield US Cents/ Passenger-km adjusted for Freight Yield US Cents/Total Tonne-km adjusted for PPP (India=1) PPP (India=1) 1.....
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....0 1.00 2.7 0.58 6.7 0.75 Source: World Bank (2012): Railways International Overview: Issues for India (12th Plan document). Table 6.3 captures the heart of the price distortions in the Indian Railways. The objective of keeping fares low for consumers has forced high freight tariffs – high even by cross-country standards. The political economy of price setting and railway operations over the years has also meant that new investments are often directed at populist projects at the cost of those that help to ease congestion and enhance productivity. Apart from the problems discussed in the earlier sections this tendency has undermined the commercial viability of railways, including the inability to generate enough internal resources to finance capital investments. More importantly, the cross-subsidization and consequently high freight charges, along with inefficiency and stressed capacity, has undermined the competitiveness of Indian industry. CPI(IW) 2011-12 2012-13 2013-14 99 100 Economic Survey 2014-15 Table 6.4 : Freight Carried; The Case of Coal in India and China India China Ratio (India/China) 1. Average distance (km) 639* 653# 0.98 2. Cost ($) 0.021* 0.016^ 1.31 3. Cost....
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....(PPP terms) ($ per ton-km) 0.064 0.029 2.21 4. Load carried by avg. freight train (ton) 1700* 3500# 0.49 5. Avg. freight train speed (km/hr) 25 34^ 0.74 Indicators 6. Time inefficiency (hours) (1/5) 25.6 19.2 1.33 7. Capacity (ton/hour)(4/6) 67 182 0.37 8. Cost inefficiency($/ton )in PPP terms (1x3) 40.89 19.23 2.13 Note*: Ministry of Railways, India. #: Statistical Yearbook, China 2013. ^: World Bank. Data on the load carried by the average freight train is for 2011. To illustrate the impact on competitiveness, we compare selected indicators of Indian railways vis- a-vis China, for coal, as it accounts for over 40 per cent of freight carried in both countries. Competitiveness, among other things, crucially depends on the cost of transporting coal (to, say, steel and power plants), the amount transported and the time taken to do so. The cost of transportation of a ton of coal, for each country, is derived by multiplying the average distance (in kilometers) travelled by the coal with the average cost (PPP adjusted $) of transportation per ton kilometer. The average distance over which the coal is transported divided by the average speed yields the time taken. Load carried by the ave....
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....rage freight train divided by the time taken yields capacity (tons carried per hour). As the ratios reported in table 6.4 indicates, China carries about thrice as much coal freight per hour vis-à -vis India. Coal is transported in India at more than twice the cost vis-à -vis China, and it takes 1.3 times longer to do so. There is some, albeit limited, scope for adjusting rates to correct these anomalies. In what follows, a few simple observations on passenger and freight prices are made based on estimate of new price elasticities for different types of passenger and Total passengers Overall suburban passengers Overall non-suburban passengers Upper class passengers Table 6.5 : Price Elasticity of Demand Per cent 14.4 23.2 13.4 9.8 Mail and express class passengers Ordinary passengers Total Freight 13.0 14.5 55.4 37.4 47.9 44.1 17.9 Petroleum and petro products Pig iron ore 91.4 33.3 Cement Coal Fertilizer Iron ore Source: MoF estimates. freight traffic.¹ There is potential for price discrimination among different passenger and freight types because of varying price elasticities (Table 6.5). It is clear from the table that freight traffic is more price sensitive than passenger....
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.... traffic. Within passenger traffic categories, upper-class passengers are less price sensitive and may be 16 The elasticities are arrived at by regressing passenger kilometers on average passenger prices (downloaded from MOSPI's infrastructure statistics report) and NTKMs on average tariff rates (identical source). They should be treated as indicative because the analysis is based on few observations and does not control for other factors that influence the choice of mode of transport. Putting Public Investment on Track: The Rail Route to Higher Growth 101 better placed to internalize prices hikes vis-à -vis other passenger classes. We also calculate the cross-elasticity of civil aviation traffic to changes in railways prices to be 5.7 percent which indicates that upper class passengers do not easily switch to airlines as a response to hikes in railway prices. Similarly, in freight categories, petroleum products are observed to be very price sensitive. Iron ore on the other hand does not easily respond to price changes. 6.4 POLICY RECOMMENDATIONS-KEY TAKEAWAYS • • Greater public investment in the railways would boost aggregate growth and the competitiveness of Indian ....
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....manufacturing substantially. In part, these large gains derive from the current massive under-investment in the railways. China invests eleven times as much in per-capita terms and underinvestment in the Indian Railways is also indicated by congestion, strained capacity, poor services, and weak financial health. In the long run, the railways must be commercially viable and public support for the railways should be restricted to (i) equity support for investment by the corporatized railways entities and (ii) for funding the universal service obligations that it provides. In the interim, there is scope for public support of railways, including through assistance via the general budget. However, any public support should be clearly linked to serious reform: of the structure of the railways; of their adoption of commercial practices; of rationalizing tariff policies; and through an overhaul of technology. What to Make in India? Manufacturing or Services? 07 1 CHAPTER "Since the industrial revolution, no country has become a major economy without becoming an industrial power." Lee Kuan Yew, delivering the Jawaharlal Memorial Lecture in New Delhi, 2005 7.1 INTRODUCTION Echoing the Sage o....
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....f Singapore, Prime Minister Narendra Modi has elevated the revival of Indian manufacturing to a key policy objective of the new government, identifying this sector as the engine of long-run growth. “Make in India" is now a flagship initiative not to mention a catchy campaign. But the question arises "What should India make?" Early development thinking, exemplified most famously (though not exclusively) in the two-sector model of Lewis (1954) was fixated on the idea of sectoral transformation: moving resources from the agricultural/traditional sector to the manufacturing/ non-traditional sector. There was never any doubt about the hierarchy (the latter was unquestionably superior) and hence no doubt about the desirability of the structural transformation. Although development thinking over the last two decades has moved away from discussions about sectoral transformation and towards a more explicit growth perspective, the importance of structural transformation is starting to be rehabilitated – but without abandoning the growth perspective. Rodrik (2013 and 2014) provides the clearest exposition of this marriage of the two perspectives. Consider the following equation: ....
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....- - Å· = ß(lny*(0) − lny) + (˜μ−πâ‚)dαm + αµ³µ³м(lnyм – ln yµ) The equation has three parts. First, growth of gdp per capita (denoted by Å·) can be viewed in a conventional conditional convergence perspective, with catch-up to the frontier (y* (Ä—)) depending on a number of fundamentals (policies, human capital, openness, institutions, etc). But this is a slow process because by definition fundamentals are slow to change. Moreover, this conditional convergence framework is inadequate because it has difficulty explaining growth miracles or accelerations—China being the classic outlier with many of these fundamentals. Hence this framework needs to be supplemented with explicit structural transformation elements. These are captured in the second and third terms of the equation. The second term captures structural change from low productivity traditional sectors (T) to high productivity modern sectors (M), where Ï€ į denotes productivity in sector i and αM denotes the share of employment in the modern sector. This is the classic dualism model, which suggests that economic development is by definition....
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.... a process of shifting resources from low to high productivity sectors, thereby raising economy-wide levels of productivity. 1 Since this chapter was written, the CSO has published new estimates of the size of manufacturing and other sectors in India. They suggest and increased in the level of manufacturing's share in GDP, although for the three years for which new estimates have been provided, there is still a decline in this share. Even the level increased owes more to statistical than ‘underlying' reasons. We thus expect the results in this chapter to remain broadly valid but cannot be definitive until the analysis is replicated for the new data. What to Make in India? Manufacturing or Services? 103 The third term is new and captures the phenomenon of unconditional convergence in the high productivity sector. Essentially, once resources move into this sector, they then experience unconditional or "automatic†catch-up due to rising productivity (represented by the convergence growth rate of the modern sector). This further increases economy-wide levels of productivity. In other words, there are two gains to shifting resources from the traditional to the new sectors: f....
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....irst, a compositional gain, which is a gain in economy-wide productivity achieved by shifting the weight of the economy from low to high productivity sectors; second, a subsequent dynamic gain as these resources experience rapid productivity growth. The contribution of Rodrik (2013) is to show empirically that the manufacturing sector does indeed exhibit this rapid growth or unconditional convergence toward the frontier: that is, manufacturing in poorer countries and less productive manufacturing activities grow faster over time. to No sooner than having adopted this framework, the question poses itself: are these compositional and dynamic gains restricted manufacturing? In other words, whereas the first phase of thinking about structural transformation was informed by certitude about the hierarchy of sectors, today there is less ground for that certitude because the comparison is not between agriculture and manufacturing but between manufacturing and services (or at least certain service subsectors). This chapter is a modest initial attempt at shedding some light on the new structural transformation question, and in particular comparing manufacturing and services. 7.2 DESIRABLE FE....
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....ATURES OF SECTORS THAT CAN SERVE AS ENGINES OF STRUCTURAL TRANSFORMATION India is taken up as a case study for addressing this question due to the poor performance of manufacturing in India and the relatively strong performance of services - which in some ways mirrors the performance of many Sub-Saharan African countries (Ghani and O'Connell, 2014). Lee Kuan Yew was clearly on to something when he challenged the Indian model of development. Historically, there have been three modes of escape from under-development: geology, geography, and "jeans" (code for low-skilled manufacturing). In recent years West Asia, Botswana and Chile, and further back in time Australia and Canada, exploited their natural resources endowed by geology to improve their standards of living. Some of the island successes (Barbados, Mauritius, and others in the Caribbean) have exploited their geography by developing tourism to achieve high rates of growth. In the early stages of their success, East Asian countries (China, Thailand, Indonesia, Malaysia etc) relied on relatively low-skilled manufacturing, typically textiles and clothing, to motor economic growth. Later on they diversified into more sophisticated....
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.... manufacturing but “jeans" offered the vehicle for prosperity early on. No country has escaped from underdevelopment using relatively skill-intensive activities as the launching pad for sustained growth as India seems to be attempting. Put differently, India seems to have defied its "natural" comparative advantage, which probably lay in the “jeans†mode of escape because of its abundant unskilled and low-skilled labor. Instead, it found or created—thanks to historical policy choices and technological accidents—such advantage in relatively skilled activities such as information technologies and business process outsourcing (Kochhar et. al., 2007). The Indian experience, still a work-in-progress, raises the question of whether structural transformation necessarily requires manufacturing to be the engine of growth. But before we compare manufacturing with alternative sectors in terms of their potential for structural transformation, it is worth elaborating on the desirable attributes of such sectors. In fact, building upon the Rodrik (2013) framework, it is argued that there are five attributes that allow a sector to serve as an engine of 104 Economic S....
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....urvey 2014-15 structural transformation and thereby lead an economy to rapid, sustained and inclusive growth: 1. High level of productivity: As described above, economic development is about moving from low productivity to high productivity activities. 2. Unconditional Convergence (i.e. faster productivity growth in lower productivity areas): This too has been discussed earlier. Recall that convergence ensures that the relevant sector acts as an “escalator†which automatically leads to higher levels of sectoral and economy-wide productivity. In fact one can distinguish between two types of unconditional convergence: A. Domestic convergence: In large countries such as India, China, Brazil, and Indonesia, one would ideally like to see convergence within a country. That is, productivity growth should be faster in richer than poorer parts. Otherwise severe within-country regional inequality may arise. B. International convergence: whereby less-productive economic units (firms, sectors or entire economies) in all countries catch-up with units at the international frontier (i.e. those in the most productive countries). 3. Expansion: To ensure that the dynamic productivity gai....
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....ns from convergence spread through the economy, it is necessary that the sector experiencing convergence absorbs resources. Convergence accompanied by contraction will fail to ensure economy-wide benefits, because the country's resources that are outside the sector in question will not experience higher, convergent productivity growth. Convergence, in the case of 2 the industrial sector, should be accompanied by natural industrialisation and not premature de- industrialisation, if it is to lead to truly inclusive growth. 4. Alignment with comparative advantage: To ensure that expansion occurs and the benefits of fast-growing sectors are widely shared across the labor force, there should be a match between the skill requirements of the expanding sector and the skill endowment of the country. For example, in a labour abundant country such as India, the converging sector should be a relatively low-skilled activity so that more individuals can benefit from convergence.2 5. Tradability: Historically, countries that had growth spurts enjoyed rapid growth in exports, typically manufacturing exports (Johnson, Ostry and Subramanian (2010)). Rapid growth has seldom been based on the domestic....
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.... market. Part of the reason for this might be that trade serves as a mechanism for technology transfer and learning, which may have spillovers on related industries (Hausmann, Hwang, and Rodrik (2007)). Perhaps a more important part is that trade and exports in particular provide a source of unconstrained demand for the expanding sector. This is particularly important for a country of India's size because of the possibility that its expansion can run up against the limited political and economic ability of trading countries to absorb Indian exports and/or to turn the terms of trade against itself. The two sectors-manufacturing and services (including services disaggregated by subsector)— are now evaluated, in succession, along these five dimensions in the Indian context.³ There may be concerns that a country's pattern of specialization (in skilled or low-skilled activities) may in turn effect the skill endowment of the country. In particular, Blanchard and Olney (2013) show that increasing exports of low-skill products tends to lower average levels of human capital attainment through a Stolper-Samuelson effect. Nevertheless, in this chapter we take the position that the a....
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....forementioned mechanism is likely to be a second-order effect in the development process. Indeed, the experience of East Asia shows that it is possible for countries to start by specializing in low-skill but dynamic activities and subsequently move to more skill intensive production once the growth process has picked up steam. ³ NB: for information on the data sources used in this chapter, please consult the working paper- Amirapu and Subramanian (2015). 7.3 What to Make in India? Manufacturing or Services? 105 THE MANUFACTURING SCORECARD 7.3.1 Productivity Level Table 7.1 compares productivity (measured simply as value added per worker) levels in the various Indian sectors — including manufacturing – for two time periods: 1984 and 2010. Several features stand out. First, in India it is highly misleading to speak generally of manufacturing because of the clear difference between unregistered manufacturing - which is a very low productivity activity-and registered manufacturing-which is an order of magnitude (7.2 times) more productive. It is registered manufacturing, not manufacturing in general, which has the potential for structural transformation. Second, the le....
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....vel of productivity in registered manufacturing is not only high relative to unregistered manufacturing, it is high compared to most other sectors of the economy and it is even high in an absolute sense, at US$ 7800 at market exchange rates and nearly three times as much at PPP exchange rates. If the entire Indian economy were employed in registered manufacturing, India would be as rich as say Korea. Third, these differentials between registered manufacturing and the rest of the economy were alreadly prevalent (if not to the same extent) in 1984 fast productivity growth over the period (about 5 percent per year) has only exacerbated the differences. - Thus, on the first criterion of high levels of productivity, registered manufacturing scores spectacularly well. 7.3.2 Domestic convergence Figure 7.1 provides evidence that registered manufacturing is characterised by unconditional domestic convergence. Here the unit of observation is the State-Industry level, but almost identical results are derived when looking at more aggregated levels (across major states in India) Table 7.1: Labor Productivity in the Indian Economy by Sector over Time Level (constant 2005 Rs.) Growth (percent) 1....
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....984 2010 1984-2010 2000-2010 Services 61,978 213,014 4.9 6.3 Manufacturing 48,817 125,349 3.7 4.2 Registered manufacturing (MOSPI) 117,984 360,442 4.4 5.4 Unregistered manufacturing 28,548 50,312 2.2 1.2 Services Subsectors Trade, Hotels, and Restaurants 56,284 144,108 3.7 Transport, Storage and Communications 68,823 172,058 3.6 24 7.3 4.5 Financial Services and Insurance 198,584 706,297 5.0 -1.6 Real Estate and Business Services, etc 1,012,017 875,073 -0.6 3.2 Public Administration and Defense 41,154 231,109 6.9 7.0 Construction 62,773 95,866 1.6 2.1 Source: Amirapu and Subarmanian (2015). 106 Economic Survey 2014-15 Figure 7.1*: Domestic Convergence in Registered Manufacturing - State-Industry level with 3 Digit Industry Fixed Effects, 1981 - 2008. growth -.05 -.1 .1 â—HP .05 AS -2 â— UP HP WB RJ MH CUMP KL RJ MRON WB AS UP GJ KA BR HOMP MMH â— RJ DL DL MH OR AP DL OB MH MP BR •UPBB EN GJ PAL POR OR PB GJ AP AP -1 0 log initial value added per worker (registered manufacturing) coef -.02501671, (robust) se = .00225602, t = -11.09 2 Source: Amirapu and Subarmanian (2015). and less aggregated levels (across factories).5 Broadly a regression coefficient on log of....
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.... initial productivity of about (-) 2.5 percent suggests that a state that is twice as rich as another has an average growth rate of productivity that is 2.5 percent slower - a considerable amount given that the average growth rate of productivity over the period 1984-2010 was about 4.4 percent. 7.3.3 International Convergence With respect to registered manufacturing, it seems that states and firms within India are converging to the Indian frontier but that could mean little unless they are also converging to the international manufacturing frontier. Are they? Rodrik (2013) shows that there is unconditional convergence across countries and sectors in manufacturing. But India is a negative outlier in the relationship in two senses: first, on average, manufacturing sectors in India exhibit labour productivity growth that is 14 percent less than the average country's manufacturing sector. Second, Indian industries converge at a much slower rate than average (0.005 percent)—almost not at all. In contrast, China is a positive outlier, posting faster labour productivity growth than average and converging faster to the global frontier. 6 Registered 4 Note that the figure is a â€....
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....partial residual plotâ€: it graphically displays the relationship between two variables while controlling for other variables when appropriate (in this case three-digit industry fixed effects). 5 Our results are also robust to different (shorter) time periods and different measures of productivity. These results and many others are reported in Amirapu and Subramanian (2015). It also worth noting that unregistered manufacturing does not exhibit unconditional convergence across the states in India. 6 More formally, when an India dummy and a China dummy are added separately, and each interacted with the convergence coefficient, the coefficient on the India dummy is -.14 (t-statistic of 1.97), and that on the India dummy interacted with the convergence term is .017 (t-statistic of 2.05). The corresponding coefficients for China are .166 (t-statistic of 2.65) and -.011 (t-statistic of 1.4). We are grateful to Dani Rodrik for providing these results. What to Make in India? Manufacturing or Services? manufacturing in India has thus not been a strong performer. 7.3.4 Expansion or Pre-mature non- Industrialisation? - It is a stylised fact that the process of development includes stage....
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....s of industrialisation followed by de- industrialisation: a country first experiences a rising share of resources - especially labour – devoted to the industrial sector, after which the services sector becomes more important, so that the share of employment in the industrial sector declines from its peak. In recent years, however, “de- industrialisation†seems to be taking place prematurely. That is, poor countries seem to be reaching their peak levels of industrialisation at lower levels of industrialisation and income (Rodrik, 2014; Amirapu and Subramanian, 2015). What about India? The phenomenon of de- industrialisation is particularly salient for India for three reasons. Looming ahead is the demographic bulge, which will disgorge a million youth every month into the economy in search of employment opportunities. Rising labour costs in China create opportunities for low-skilled countries such as India as replacement destinations for investment that is leaving China. And a new government that has assumed power offers the prospect of refashioning India in the image of Gujarat-one of the few manufacturing successes. 107 But the sobering fact is that India seems t....
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....o be de- industrialising too. In fact, to call the Indian phenomenon de-industrialisation is to dignify the Indian experience, which is more aptly referred to as premature non-industrialisation because India never industrialised sufficiently in the first place. To make the point first consider Figure 7.2, which plots the share of manufacturing in total employment over time for South Korea, a poster child for manufacturing-led growth. South Korea's GDP per capita in 2005 PPP dollars is also shown alongside the series for several years. The figure displays the typical shape: share of employment in manufacturing starts very low at around 5 percent and rises over time to almost 30 percent before starting to decline after a fairly high level of GDP has been reached. In contrast, Figure 7.3 illustrates the Indian experience. The Figure shows India's share of registered manufacturing in total output and employment over time (on the same axes as the graph for Korea). The general trend is constant with a downward trend over the last few years for which data are available. In other words, the pronounced inverted U shape that characterises the cross-section and Korea is notably absent in Indi....
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....a. But what has been the counterpart development among Indian states? Tables 7.2A and 7.2B show Figure 7.2: Share of Manufacturing in Total Employment over Time, 1960-2010: South Korea (GDP per capita in 2005 PPP $ show for select years) Figure 7.3: Share of Registered Manufacturing in Total Output and Employment over Time, 1980-2010: All India .3- share of manufacturing in total employment .05 55 .15 2 . .1 1272 ⚫3644 • 6166 16325 24047 0- 1960 1970 1980 1990 2000 2010 Year Source: Amirapu and Subarmanian (2015). share of registered manufacturing .25 25 .15 .1 .05 .2 1980 1990 2000 2010 Year total employment total output (3 yr moving avg) Source: Amirapu and Subarmanian (2015). 108 Economic Survey 2014-15 the year in which the share of registered manufacturing peaked (in first value added and then employment terms), the peak share of registered manufacturing (in value added or employment), and the per capita GDP associated with peak registered manufacturing levels. From the tables, a few points are striking. Gujarat has been the only state in which registered manufacturing as a share of GDP surpassed 20 percent and came anywhere close to levels achieved by the major man....
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....ufacturing successes in East Asia. Even in Maharashtra and Tamil Nadu, manufacturing at its peak accounted for only about 18-19 percent of state GDP. The peak shares in employment terms are even less significant: no major Indian state has achieved more than 6.2 percent of employment from registered manufacturing in the last 30 years, and many major states peaked at less than half that. Even in Gujarat, employment in registered manufacturing has only been about 5 percent of total employment, while annual growth in registered manufacturing employment has been 1.8 percent between 1984 and 2010 (slower than the growth rate of total employment over the period: 2.4 percent). Second, in nearly all states (with the exception of Himachal Pradesh and Gujarat), registered manufacturing as a share of value added is now declining and, for most states, has been doing so for a long time. The peak share of manufacturing in output for many states was reached in the 1990s (Andhra Pradesh and Tamil Nadu) or even in the Table 7.2A : Premature Non-Industrialisation among Indian States (by Value Added) State Year in which registered manufacturing in value added peaked Share of registered manufacturing i....
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....n value added at peak (percent) NSDP per capita GSDP per at peak (2005 INR) capita at peak (2005 USD PPP) Gujarat Maharashtra 2011 22.7 52,291 5,357 1986 18.9 15,864 1,400 Tamil Nadu 1990 18.1 15,454 1,417 Haryana 2003 17.3 32,869 3,309 Himachal Pradesh 2011 16.4 46,207 4,733 Karnataka 2008 14.7 34,752 3,523 Bihar 1999 13.6 9,215 905 Madhya Pradesh 2008 12.5 18,707 1,897 West Bengal 1982 12.3 9,348 909 Orissa 2009 12.0 22,779 2,353 All India 2008 10.7 30,483 3,091 Punjab 1995 10.5 25,995 2,506 Kerala 1989 10.3 14,418 1,322 Andhra Pradesh 1996 10.0 16,904 1,641 Uttar Pradesh 1996 10.0 11,679 1,134 Assam 1987 10.0 12,904 1,164 Delhi 1994 8.5 39,138 3,742 Rajasthan 2001 8.3 15,816 1,522 Source: Amirapu and Subarmanian (2015). What to Make in India? Manufacturing or Services? 109 Table 7.2B : Premature Non-Industrialisation among Indian States (by Employment) State Year in which registered manufacturing in Share of registered NSDP per capita GSDP per manufacturing in employment at peak at peak (2005 INR) capita at peak (2005 USD value added peaked (percent) PPP) Tamil Nadu 2010 6.2 44,033 4,633 Delhi 1988 6.1 31,531 2,989 Haryana 2010 6.1 54,861 5,773 Punjab 2010 5.4 44,611 4,694 Gujar....
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....at 1984 5.4 15,167 1,343 Maharashtra 1984 4.8 15,212 1,347 West Bengal 1984 4.7 10,371 919 Himachal Pradesh 2010 3.8 42,998 4,524 Kerala 1994 Karnataka 2010 33 3.3 18,926 1,809 3.3 36,214 3,811 Andhra Pradesh 2010 2.8 36,228 3,812 All India 1984 2.7 11,800 1,045 Assam 1984 2.5 13,238 1,172 Uttar Pradesh 1988 1.6 9,372 888 Bihar 1988 1.5 4,768 452 Rajasthan 2010 1.4 23,908 2,516 Madhya Pradesh 1994 1.4 13,191 1,261 Orissa 2010 1.4 22,677 2,386 Source: Amirapu and Subarmanian (2015). 1980s (Maharashtra). Interestingly, peak employment shares seem to be following a slightly different story, with less marked declines observable for most states. Nevertheless, most states have not been experiencing secular growth in employment shares over time (the only exceptions are Himachal Pradesh, Tamil Nadu, Haryana and – possibly – Karnataka). Many of the states that do exhibit peak years in 2010 (such as Andhra Pradesh, Rajasthan and Orissa) seem to have employment shares that have been mostly flat, reflecting neither relative growth nor decline. Third, and this is perhaps the most sobering of facts, manufacturing has even been declining in the poorer states: states that never effec....
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....tively industrialised (West Bengal and Bihar) have started de-industrialising. Some comparisons are illuminating. Take India's largest state Uttar Pradesh. It reached its peak share of manufacturing in output at 10 percent of GDP in 1996 at a per capita state domestic product of about $1200 (measured in 2005 purchasing power parity dollars). A country like Indonesia attained a manufacturing peak share of 29 percent at a per capita GDP of $5800. Brazil attained its peak share of 31 percent at a per capita GDP of $7100. So, Uttar Pradesh's maximum level of industrialization was about one- third that in Brazil and Indonesia; and the decline began at 15-20 percent of the income levels of these countries. Thus far, we have shown that, for all but a few states, Indian manufacturing is certainly not growing and is probably shrinking. One possible 110 Economic Survey 2014-15 consequence of manufacturing failing to satisfy requirements 2b and 3 is that, in contrast to China, there is no evidence of convergence between states in India in overall per capita GDP. For Chinese provinces, the poorer the initial level of per capita GDP, the faster the subsequent growth, so that poorer provinces st....
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....art catching up with richer ones. In India, there is no convergence, because poorer states are not likely to grow faster than richer ones on average (Amirapu and Subramanian 2015). Regional disparities have thus persisted within India. Had manufacturing attracted resources while exhibiting domestic convergence in productivity, the sector would have expanded in poorer states increasing overall levels of income in these states and contributing to a narrowing of the income distribution across India. Instead it seems that manufacturing has failed to be such an escalator of progress. Several explanations are possible for why manufacturing has not been this escalator in India. They fall under four broad categories: distortions in labour markets; distortions in capital markets; distortions in land markets; and inappropriate specialisation away from India's natural comparative advantage and toward skill intensive activities. Amirapu and Subramanian (2015) provides some evidence in support of the last explanation. 7.3.5 Alignment with Comparative Advantage As argued earlier, in order for a sector to offer transformational possibilities, it must not only be characterised by high levels and g....
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....rowth rates of productivity, it must also absorb resources from the rest of the economy. But in order to do so, the sector's use of inputs must be aligned with the country's comparative advantage. That will allow the abundant factor of production (usually unskilled Table 7.3: Average Skill Level by Subsector in the Indian Economy (NSSO 2004-05) Sector/Subsector Share of Employees with at least Secondary Education Share of Employees with at least Primary Education Agriculture, forestry and fisheries 0.445 0.139 Mining 0.501 0.221 All manufacturing 0.628 0.248 Registered manufacturing (workers in factories with >10 workers) 0.768 0.432 All Services 0.778 0.478 Transportation and communications 0.715 0.330 Wholesale and retail trade 0.721 0.346 Financial services and insurance 0.976 0.836 Real estate and business services 0.935 0.775 Public administration and defense 0.897 0.665 Education 0.963 0.888 Health and social work 0.924 0.767 Electricity, gas and water 0.856 0.558 Construction 0.518 0.144 Source: Amirapu and Subarmanian (2015). What to Make in India? Manufacturing or Services? labour) to benefit from productivity growth and convergence, and in so doing make growth not only ra....
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....pid and sustainable but also inclusive. In other words, the dynamic sector must at least initially be relatively unskilled labour intensive. Is this true of India manufacturing? Kochhar et. al. (2006) found that Indian manufacturing was unusually skill labour intensive. Another simple metric for assessing the alignment of dynamism with comparative advantage is the relative skill intensity of manufacturing relative to other sectors. Table 7.3 presents some numbers. From the 2004/5 NSSO Employment and Unemployment Survey, the share of employees with at least primary and secondary education for major sectors (and subsectors) of the Indian economy is computed. It turns out that registered manufacturing is a sector that is relatively skilled labor intensive. As table 7.3 shows, the share of workers with at least secondary education is substantially higher in registered manufacturing than in agriculture, mining or unregistered manufacturing and also greater than in several of the service subsectors. In some ways, this should not be surprising. High labour productivity in this sector (Table 7.1) is at least in part a consequence of higher skills in the work force. What it does suggest, ho....
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....wever, is that registered manufacturing does not really satisfy 111 requirement number four. The skill intensity of the sector is not quite aligned with India's comparative advantage. 7.4 The Services ScorecarD The scorecard analysis can be repeated for the services sector in India. But before that is done, it is important to recognise that services in the aggregate is not a useful category of analysis because it is an amalgam of different and disparate species of economic activity, from government services and construction that are non-tradable to finance and business services that largely are tradable; from certain activities that are labour intensive and others such as telecommunications that are highly capital and skill labor intensive. Any meaningful analysis of services must distinguish between different service subsectors—although the degree of disaggregation will of course be determined by data availability. We work with the six different subsectors shown in Table 7.4 and repeat the analysis undertaken above for registered manufacturing. 7.4.1 Productivity Level Table 7.4 provides comparative data on the level of productivity for these service subsectors as well Tabl....
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....e 7.4: Growth in Employment Shares of Economy Subsectors, 1984-2010 Initial Level of Productivity Employment Shares Annual Growth (percent) 1984 1984 2010 1984-2010 Registered Manufacturing 117,984 0.027 0.026 -0.2 Aggregate Services 61,978 0.201 0.219 0.3 Trade, Hotels, and Restaurants 56,284 0.074 0.093 0.9 Transport, Storage and Communications 68,823 0.028 0.038 1.2 Financial Services and Insurance 198,584 0.006 0.007 0.7 Real Estate and Business Services, etc 1,012,017 0.002 0.011 7.1 Public Administration and Defense 41,154 0.030 0.018 -1.9 Construction 62,773 0.031 0.080 3.7 Source: Amirapu and Subarmanian (2015). 112 Economic Survey 2014-15 as for manufacturing (both registered and unregistered). The first point to note is the astounding variation within services, reinforcing the case for disaggregation. In 1984 for example, the level of productivity in the real estate and business services sectors was 25 times as much as in public administration (essentially government) and close to 20 times as much as in retail. The productivity levels in two financial services and business services out of six service subsectors exceed that of registered manufacturing. 7.4.2 Domestic conve....
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....rgence The issue of whether there was unconditional convergence within India for service subsectors over the last 3 decades is now examined. Notably, unconditional domestic convergence is found in nearly all the service subsectors, and across many time horizons (not reported here). In fact, the speed of domestic convergence for most service subsectors is found to be similar to that in registered manufacturing (about 2 percent) and, in some cases, substantially higher. For example, real estate and business services seem to converge at double the rate at which registered manufacturing converges. 7.4.3 International Convergence Rodrik (2013) provides evidence using UNIDO data that industries in the (organized) manufacturing sector consistently exhibit global convergence in labour productivities, although Indian manufacturing industries converge to the global frontier much more slowly than the average, if at all. What about the service subsectors? Using data on sectoral productivities from the World Bank's World Development Indicators (WDIS), Ghani and O'Connell (2014) argue that services in the aggregate have also exhibited convergence to a similar or even greater degree than manufact....
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....uring - at least for recent time periods (approximately 1990 to 2005). This is an interesting finding, but for this analysis in particular services should be disaggregated as we might well expect convergence behaviour to vary by subsector due to significant differences in sectoral characteristics such as tradability. Table 7.5: Unconditional Convergence in Service Subsectors across Countries (1990-2005), regressions include productivity growth against log of initial productivity Log of initial productivity Trade, Transport, Hotels and Storage and Restaurants Communication Finance, Community, Construction Insurance, and Real Social and Personal Estate Services (3) (4) (5) Trade, Hotels and Restaurants (1) -0.007 (0.005) (2) Transport, Storage and Communication -0.00 (0.008) Finance, Insurance, and Real Estate -0.031*** ((0.007) Community, Social and Personal Services Construction -0.030*** ((0.008) -0.026*** (0.008) Constant Observations 0.061 (0.053) 27 0.105 (0.083) 0.325* ((0.076) 0.315** (0.094) 0.269*** (0.085) 27 27 9 27 Standard errors in parentheses * p<BR> News - Press release - PIB....