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Countries and Regions Country Assistance Plans Document
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Country Assistance Plans - India : I. Country Performance Assessment
A. Economic Performance Assessment1. In the early 1990s, the Government launched a decisive break from the formerly closed and regulated policy regime by liberalizing economic policies and adopting an outward-oriented approach. Substantial progress was initially made in liberalizing industry, trade, investment, and the exchange rate regime, as well as reforming the financial sector and strengthening capital markets. This opened up almost all areas of the economy to domestic and foreign private investment, bringing about the integration of the Indian economy into the global economy. In parallel, sound macroeconomic management reduced the severe internal and external imbalances, and provided a basis for sustained higher economic growth. Real gross domestic product (GDP) growth recovered rapidly from less than one percent in fiscal year 1992 (FY1992) to 7.5 percent in FY1997, without fueling inflationary pressures (see Appendix 1). Unlike in the past, economic expansion was driven by private investment rather than public sector expenditure, reflecting inter alia the efforts at reducing the government fiscal deficit, as well as improving the incentive structure for private sector resource allocation. 2. India's strong economic performance through FY1997 and its trend-like improvement in economic growth, however, could not be sustained. Cyclical factors, both on the demand and supply sides, have played an increasing role in the growth pattern in recent years. Real GDP growth slowed to 5 percent in FY1998, accelerated to 6.8 percent in FY1999, and is estimated at 6.4 percent in FY2000, mainly reflecting large fluctuations in agricultural production as well as changes in consumption and investment demand of the private and public sectors. The return of political stability after the general elections in late 1999 has again boosted private sector investor confidence. 3. The fiscal situation of the central and state governments has substantially worsened. The Central Government fiscal deficit (excluding small savings), which was reduced to 4.1 percent of GDP in FY1997, surged to average 5 percent of GDP in FY1998-FY1999, and is estimated to have reached 5.6 percent of GDP in FY2000, substantially above the budgeted 4 percent level. Shortfalls in revenues, reflecting inter alia lower disinvestment proceeds, were exacerbated by a surge in current expenditures, particularly due to wage adjustments associated with the implementation of the Fifth Pay Commission recommendations, relief expenditures due to natural calamity (e.g. supercyclone in Orissa), outlays for elections, and unanticipated increase in defense expenditures. Despite a windfall of almost 0.5 percent of GDP on account of proceeds from a government tax amnesty program shared with the states, and further fiscal assistance from the Central Government, the states' consolidated budgetary deficit increased from 2.8 percent of GDP to 4.3 percent of GDP during FY1998-FY1999. The deficit is expected to have remained at about 4 percent in FY2000. The states' rising fiscal imbalances and the deteriorating expenditure composition towards wage/salary expenditure, interest payments, and subsidies-notably in the power and irrigation sectors-are increasingly constraining capital expenditures and impinging on the resource availability for social development. Unless decisive measures are taken to reverse this development, increasing Central and state government deficits will heighten the risk of a domestic debt trap. As a first step towards renewed effort at fiscal consolidation, the Central Government's FY2001 budget envisages a reduction in the fiscal deficit by 0.5 percent of GDP, mainly by curbing built-in expenditure growth through zero base budgeting, and by reducing outlays on food and fertilizer subsidies (about 0.3 percent of GDP). Although military expenditure increased, total nonproductive expenditure has been contained through reductions in subsidies2. Structural measures in the Budget include rationalization of the excise duty system, lowering of the maximum customs duty rate and elimination of quantitative import restriction, as well as strengthening fiscal incentives for investment in urban infrastructure. The Budget also stipulates Government's intention to reduce its stake in non-strategic public sector undertakings to 26 percent, and raises the limit on equity holdings by foreign institutional investors, in an effort to further improve the environment for domestic and foreign investment. 4. The balance of payments has remained in a comfortable position during FY2000, with a manageable current account deficit and increasing foreign exchange reserves. Higher export growth was largely offset by a sharp increase in oil imports. However, capital flows-led by portfolio inflows and non-resident deposits-continued to remain strong, enabling the build-up of reserves, as foreign investment inflows at $5.2 billion (FY2000) were significantly higher than previous year's level of $1.6 billion, although foreign direct investment were 12 percent below the FY1999 level of $2.2 billion. Despite the surge in international reserves and the pressure on the public finances, prudent monetary management succeeded in containing monetary expansion. Lower inflation and a relatively stable value of the rupee enabled a gradual easing of monetary conditions through lowering of cash reserve requirements and reduction in key interest rates during FY2000. However, as pressure on the rupee increased, in July 2000 the Reserve Bank of India tightened monetary policy by raising the Bank rate and reserve requirements. 5. While India's overall economic performance, particularly seen in the context of volatile external environment and prolonged political uncertainties, has faired quite well, several critical reforms need to be addressed. A key outstanding issue is the need to reduce central and state fiscal imbalances and to reverse the deterioration in the expenditure composition3. Slow progress in the reform of public enterprises, as well as delay in adjustment of administered prices, continues to adversely affect domestic saving. Another key constraint facing the economy is the country's seriously inadequate infrastructure. Uncertainties over the policy, legal, and regulatory frameworks in key infrastructure sectors continue to act as a constraint to increasing private sector involvement. A further deepening of the capital market and financial sector reforms are also a prerequisite to strengthening financial intermediation, fostering availability of long-term infrastructure financing, facilitating public-private partnership in infrastructure development, and enhancing the effectiveness and efficiency of fiscal debt management. Finally, while the agriculture sector has benefited from trade and exchange rate reforms, the sector has remained heavily regulated with controls on movement, storage, and trade on most major food and industrial crops. 6. Although this is a demanding reform agenda, the constraints outlined above will need to be addressed if the country is to move to a higher, and more sustainable, rate of economic growth. To this end, the Ninth Five-Year Plan (1997-2002) acknowledges the need for sound macroeconomic policies and calls for an acceleration of structural reforms. Recognizing that sustained economic growth is a prerequisite for poverty reduction, the Plan envisages annual GDP growth of average 7.4 percent for the perspective period 1997-2012 4 to eliminate widespread poverty. However, this growth target appears optimistic given the severe resource constraints, and the existing bottlenecks in infrastructure. ___________________
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