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Regions and Countries Country Partnership Strategy Document
Country Strategy and Program Update 2005-2007: India
I. Current Development Trends and IssuesA. Recent Political and Social Developments1. There have been significant political developments in India since the finalization of the Country Strategy and Program: 2003–2006 (2003 CSP) in April 2003. General elections were held in April–May 2004, along with state elections in Andhra Pradesh, Karnataka, and Orissa. The elections, the largest ever held anywhere in the world, were conducted electronically, and results were declared within a few hours after counting began. State elections had also been held a few months earlier in Delhi, Gujarat, Madhya Pradesh, and Rajasthan. The political landscape has changed significantly as a result of these elections. At the federal level, the United Progressive Alliance (UPA) led by the Indian National Congress has come to power, supported by the Left Democratic Front (LDF), although the latter has not joined the Government.1 The UPA plus LDF have a majority: 277 of 543 seats in Parliament. The UPA is also in power in 12 states. The National Democratic Alliance, led by the Bharatiya Janata Party, has lost power at the federal level but continues in power in eight states. The LDF and some regional parties are in power in the other nine states. 2. The UPA and LDF have adopted a National Common Minimum Program (NCMP) emphasizing, among other things, equitable social and economic policies. The architect of India’s economic reforms since 1991 has been appointed the current Prime Minister. Together with the Finance Minister, the Deputy Chairman of the Planning Commission, and the Governor of the Reserve Bank of India, this constitutes a strong team of committed and highly experienced reformers at the helm of economic affairs. This is good for the economy. At the same time, this is also a coalition government with many parties, each with its own agenda. Decision making will, thus, be based on negotiations, compromises, and consensus building within the alliance. B. Socioeconomic Assessment and Outlook3. Macroeconomic performance is the first of four performance evaluation blocks adopted in the CSP (2003 CSP, para. 56). Performance on this front during the past year has been impressive. The economy grew by 8.2% in FY2003,2 making India one of the world’s fastestgrowing economies. Growth could have been even higher had it not been for the “crowding out” effect of a large fiscal deficit. High growth in FY2003 is the culmination of nearly 15 years of reforms, and, in addition to a good monsoon, reflects the broad-based upswing of a business cycle, led by both investment and consumption demand, that is riding on an underlying longterm trend of accelerating growth. Thus, high growth is likely to be sustained during 2005–2007, unless there are major shocks. This expectation is reinforced by other macroeconomic and sectoral indicators. A large increase in foreign exchange assets has led to accelerated monetary expansion. Growth in money supply (M3) rose from about 11% earlier in the year to 15.8% by 19 March 2004. Consequently, inflation has slowly increased from 3.4% in FY2002 to 5.5% in FY2003 and is still rising.3 Meanwhile, performance in the external sector has been robust. Merchandise exports grew at 19.9% while imports grew at 21.8%, driven by strong domestic absorption. Despite imports growing faster than exports, there was a current account surplus of 1.4% of gross domestic product (GDP) because of a sharp rise of 49.1% in invisible earnings, especially earnings from software services and business processes outsourced to India. The current account surplus, plus net inflows on the capital account, raised foreign exchange reserves to $107.4 billion in FY2003, with an estimated net inflow of $35.6 billion during the year. Unfortunately, foreign direct investment accounted for only $4.6 billion of this. The rest was portfolio investment and other short-term flows. After prepayment of $4.4 billion foreign debt, the external debt:GDP ratio is now a prudent 17.8%, and the debt service ratio is estimated at only 10.4%. Thus, the short-term economic outlook is promising. But there are risks. Growth could decline significantly if the high price of oil persists, or there is a weak monsoon, or slippages in fiscal consolidation. As the Tenth Five Year Plan for 2002-2003 to 2006-2007 (10th Plan) points out, poor infrastructure, dysfunctional bureaucratic controls, inertia, and corruption also remain important impediments to growth. 4. Progress on policy reform is another performance evaluation block in the 2003 CSP. During the past year, the Government enacted the Fiscal Responsibility and Budget Management Act, which requires elimination of the revenue deficit by FY2007.4 The federal fiscal deficit, which decreased from 5.4% in FY2002 to 4.8% in FY2003, is projected to decline further to 4.4% of GDP in FY2004. The revenue deficit is estimated at 2.5% of GDP in FY2004. Among other recent reform measures, the Electricity Act was enacted in FY2003, laying the legal foundation for comprehensive power sector reform. The Securitization, Reconstruction of Financial Assets and Enforcement of Security Interest Act was also enacted. This Act allows banks to foreclose collateral assets for non-performing loans. It also provides a comprehensive legal framework for the formation of private asset reconstruction companies—an important landmark for financial sector reforms. There was also significant progress in public sector disinvestments, and further liberalization in telecommunications and other sectors. 5. The FY2004 budget of the new Government has translated the NCMP vision to specific fiscal measures to address the challenges of poverty and unemployment by increasing expenditures on primary education, basic health care, agriculture, irrigation, and rural infrastructure. This was done without strong revenue mobilization measures other than the introduction of an education cess, an increase in the service tax rate from 8% to 10% with expanded coverage, and a transactions tax to replace the long-term capital gains tax. However, since this budget was prepared within a very short time and introduced around the middle of the financial year, the Finance Minister announced that he will propose his major tax reforms in the FY2005 budget. The budget also announced that although no profit making public enterprises will be privatized, disinvestments of their equity will be permitted up to certain ceilings. Furthermore, the budget has announced several new measures to encourage foreign direct investment (FDI). 6. Performance in accomplishing millennium development goals (MDG) targets is a third evaluation block in the 2003 CSP. This is a particular concern in the context of India’s dualism, a modern and fast growing 21st century economy alongside the “other India,” still engulfed by poverty and underdevelopment. Latest available estimates indicate that the picture is mixed, though there have been impressive gains in recent years on important MDG indicators (Chapter II, Section A). Furthermore, there remain concerns about large interregional disparities in growth, and persisting interstate variations in per capita income. Equally troubling is the persistence of social exclusion. It is encouraging that the NCMP has identified most of these challenges as requiring urgent attention. C. Implications for Country Strategy and Program7. Political and economic developments since finalization of the 2003 CSP indicate that its assistance strategy remains valid, especially the mainstreaming of poverty reduction, and the core strategy of poverty reduction through infrastructure-led growth, supported by social development and good governance.5 But some aspects of the strategy should be strengthened, namely, ADB’s operations in agriculture and rural development, and the shift in focus of statelevel operations to poorer states and less-developed regions, especially the northeastern states. An important breakthrough in the 2003 CSP was the introduction of an ADB program for agriculture, irrigation, and rural development. Since 75% of India’s poorest citizens are in the rural sector, the impact of agriculture and rural development on poverty reduction can be immediate. The new Government has accordingly given this sector highest priority. ADB is stepping up and consolidating its assistance for the sector. Growing inter-regional disparities are also a major concern of the Government. Assistance to help contain this through diversification of ADB’s state-level operations to poorer states, including northeastern states, has been requested. Thus, this component of ADB’s assistance program is also being enhanced. 8. The assessment in section B indicates that macroeconomic performance during the year has been excellent, and is expected to continue. Progress was also good during the year on reforms in several sectors. Performance on poverty reduction and the MDGs has been mixed, despite significant gains in many MDGs. Portfolio performance, the last evaluation block in the 2003 CSP, was also good during the year (Chapter III). Finally, regarding absorption capacity, India is maintaining a prudent external debt:GDP ratio of 17.8%, with a debt servicing ratio of only 10.4%. Thus, it seems appropriate to maintain the overall assistance level programmed in the 2003 CSP, and the broad profile of the program, subject to the adjustments cited. However, within this overall ceiling of planned assistance, actual assistance will depend on continuing strong performance. __________________________
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