Countries and Regions

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p. 1 of 4 BACK | NEXT I. Development Situation II. Implementation of the Country Strategy and Program III. Portfolio Management Issues IV. Country Performance and Lending Levels

Country Strategy and Program Update 2002-2004: India

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I. Development Situation

A. Recent Political and Social Developments

1. India remains under the G7¹ partial sanction regime following its nuclear testing in May 1998 and for not yet being a signatory to the Comprehensive Test Ban Treaty.

2. The present Government, the National Democratic Alliance (NDA) led by the Bharatiya Janata Party, is a coalition of 25 parties, many of which are regional or caste-based. State elections in five Indian states and union territories (Assam, Kerala, Pondicherry, Tamil Nadu, and West Bengal) were held on 10 May 2001. The elections were regarded as a test of the political strength of the national and regional parties, especially those belonging to the NDA. Indeed, results indicate a generally strong anti-incumbency vote, with gains by the opposition Congress Party in three of the states, including Kerala and Assam. The incumbent Communist Party has maintained its lead in West Bengal.

3. In late 2000, Madhya Pradesh, Uttar Pradesh, and Bihar states were bifurcated to create three new states: Chhattisgarh, Uttaranchal, and Jharkhand. As a result, India now has 28 states rather than 25. Chhattisgarh has about 30 percent of Madhya Pradesh’s former territory, 26 percent of the population and, although industrially more backward, has 40 percent of the mineral wealth. The new state will also be assigned a substantial portion of existing power-generating capacity, making Chhattisgarh a power-surplus state.

B. Economic Assessment and Outlook

4. Real gross domestic product (GDP) grew at estimated 5.2 percent in fiscal year (FY) 2001 reflecting growth of 0.2 percent in agriculture, 5.6 percent in industry, and 7.7 percent in services (Appendix 1). Although still comparatively high, economic growth was below expectation reflecting unfavourable monsoon in some of the regions, and the sluggish industrial sector. Annual wholesale price (WPI) inflation slowed to 4.9 percent (point-to-point basis) in FY2001, compared with 6.8 percent a year ago, mainly due to a moderation in petroleum prices and excess industrial capacity, although on an annual average basis it exceeded last year’s level. Excluding fuel price changes, inflation was 2.6 percent. Meanwhile, consumer price inflation was below WPI changes, at 2.5 percent point-to-point (3.8 percent on average basis). Money supply (measured by M3) grew by 16.2 percent as against 14.6 percent a year ago, reflecting large inflows of India Millenium Deposits (IMD)—five-year deposits from nonresident Indians; net of IMD inflows, monetary expansion was 13.9 percent.

5. The balance-of-payments position remained comfortable during the fiscal year, with slight improvement in the trade balance, a manageable current account deficit, and increasing foreign exchange reserves. Exports grew by 20 and 15 percent during the first and second half of FY2001, respectively, while a moderate increase in nonfuel imports helped contain overall imports. Reserves exceeded $40 billion, or about eight months of import equivalent by end-March 2001. Notwithstanding, marked external fluctuations from May to mid-August 2000—high oil prices, combined with successive increases in US and European interest rates and lower capital inflows— led to a decline in India’s foreign assets by $2.5 billion and a 5 percent depreciation of the rupee against the US dollar in the early part of FY2001. Meanwhile, the second half of FY2001 saw a sharp turnaround, with foreign assets increasing by $7 billion (including $5.5 billion from the IMD scheme of the State Bank of India), and more orderly exchange rate movements.

6. The Government fiscal deficit, which had surged to 5.4 percent of GDP in FY2000, declined to 5.1 percent in FY2001, due to strengthening of direct tax revenue collection resulting from a broadening of the tax base, an increase in dividend taxes and higher corporate tax collection, as well as reduction in current expenditure. For medium-term fiscal management, a Fiscal Responsibility and Budget Management Bill was introduced in Parliament in December 2000 stipulating gradual phasing out of revenue deficit over a five-year period. In line with this Bill, the FY2002 budget sets a fiscal deficit target of 4.7 percent of GDP. The budget also addresses important measures for further reforms: (i) downsizing the Government by reducing staff in six ministries as recommended by the Expenditure Review Commission; (ii) labor market reforms allowing companies to lay off staff and use short-term contract labor; and (iii) reduction in customs tariffs.

7. States’ fiscal situation remains precarious, with fiscal deficit above 4 percent and a further surge in outstanding debt. In view of the potential fiscal crisis, the Government concluded memorandums of understanding with 13 states, detailing reform programs and financial assistance. Although individual memorandums were drawn up, a set of common objectives has emerged: (i) downsizing state governments; (ii) compressing current expenditure; (iii) mobilizing additional resources; and (iv) public sector divestment and restructuring. The memorandum of understanding process complements reform efforts supported by ADB and other funders through public resource management programs.

8. India’s medium-term economic success depends on the Government’s ability to address the country’s structural weaknesses, particularly in infrastructure and public finance. As India continues to suffer from gross inequities in the delivery of basic education and health services, support for social infrastructure and human development must be strengthened to make the reform process sustainable. In key areas, particularly power and roads, investments have failed to keep pace with developments in the overall economy and have thus emerged as a major impediment to sustainable poverty reduction. Given the enormous resources required to improve infrastructure, central and state governments need to (i) promote private sector participation; (ii) strengthen policy coordination among different government agencies in implementing large infrastructure projects; and (iii) foster availability of long-term funding. These measures should be complemented by others to make public resource management more efficient, particularly by strengthening tax and nontax revenues, including by (i) raising utility prices, (ii) rationalizing expenditures and curtailing subsidies, and (iii) restructuring and divesting public sector enterprises. State government fiscal reforms must also reallocate resources to growth-inducing and socially productive investments to strengthen the states' capacity to deliver economic and social services and thereby foster socioeconomic development.

C. Implication for the Country Strategy and Program

9. The relatively stable macroeconomic and political situation, notwithstanding recent political events, will enable implementation of the country strategy and program (CSP). The Government is implementing its reform agenda and fully supports the contribution of ADB’s assistance as reflected in the medium-term program. However, ADB’s lending to India for social sectors¾particularly direct poverty interventions¾has been constrained by India’s strong emphasis on external sustainability and the cost of funding, and its access to World Bank concessional funds without access to ADB’s concessional resources. Instead, ADB contributes to poverty reduction primarily by supporting higher and sustainable pro-poor economic growth and the integration of social dimensions, especially through state-level operations. A review of the country strategy will explore possibilities for expanding its lending program into sectors with more direct impact on poverty.

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