Macroeconomic Overview1. The Economic Survey 1995-96 noted that India recorded one of the fastest recoveries from a macroeconomic and balance of payments crisis. It also stated that the growth achieved in the post-crisis period was a noteworthy achievement by international standards and was more sustainable than the growth in the immediate pre-crisis period. Data which has become available since then shows an even more buoyant outcome (Table 1). Overall economic growth of GDP at factor cost, after rising to 6.3 per cent in 1994-95, accelerated further to 7 per cent in 1995-96. More remarkably, this is the first time that a growth rate of this magnitude was not due to exceptional agricultural growth. Since 1970-71, there have been only five years in which the growth rate reached or exceeded 7 per cent. Every one of these years was associated with a growth rate of 10 per cent or higher in the agriculture, forestry and fishing sector. In 1995-96, not only was the growth of this sector low, at 2.4 per cent, it was lower than the average growth of the agriculture and allied sectors over the nineties. The high growth was therefore due mainly to the 11.7 per cent growth of industry and construction sector and the 7 per cent growth of the services sector (Table 2). Overall economic growth during the first four years of the Eighth Plan averaged 5.9 per cent per annum, a rate significantly higher than the Plan target of 5.6 per cent.
2. Industrial production grew by 12.4 per cent during April 1995 to February 1996, while agricultural crop production is estimated to have grown by only 0.9 per cent. The decline in foodgrain production by 0.4 per cent in 1995-96, coupled with high levels of open market sales, has reduced public food stocks from a record level of 35.6 million tonnes in July 1995 to 22.7 million tonnes in April 1996. At this level, food stocks are 50 per cent larger than the prescribed buffer stock norms. However, the watchword must be prudent and cautious management. On the inflation front, the resurgence of inflationary pressure in 1994-95 was significantly reversed in 1995-96. Inflation, as measured by the WPI, dropped from a high of about 12 per cent in January 1995 to a low of 4.2 per cent (provisional) on June 22, 1996. The recent increase in administered prices of petroleum products is likely to result in a one time jump in the rate of inflation, with a gradual tapering off to the underlying inflation rate.
3. The economic reforms have led to a marked and favourable turnaround in the performance of the external sector since the crisis of 1991. Highlights include:
1. a strong and sustained recovery in export growth;
2. a pronounced rise in the ratio of exports to imports from the level prevailing at the turn of the decade;
3. a substantial decline in the current account deficit as proportion of GDP from the unsustainable level of 3.2 per cent in 1990-91;
4. strong growth in foreign direct investment flows since 1991-92 and in foreign portfolio investment flows since 1993-94; and
5. an increase in foreign currency reserves from $2.2 billion in March 1991 to over $20 billion in March 1995 which, however, declined to $17 billion in March, 1996. However, during 1995-96, though export growth remained buoyant at 21 per cent in dollar terms, the balance of payments came under some pressure from the continued surge in import growth (which had started in 1994-95), a substantial decline in portfolio investment flows in the form of GDRs and a sizeable increase in debt service payments on liabilities accumulated in earlier years.
4. During April-May 1996, both export and import growth have slowed from last year's pace. Exports grew by 14.4 per cent, in dollar terms, over the corresponding period of 1995, while imports grew by 23.4 per cent (DGCI&S data). The recent aggregate import growth figures, however, mask two potential trends, one positive and the other negative. While non-POL import growth at about 17.2 per cent in the first two months of 1996-97 is about half that for the corresponding period of last year, POL growth has almost tripled to 47.6 per cent. This is at least partly attributable to non-adjustment of domestic oil prices for two and a half years, delays in decontrol of energy prices and lack of fair and transparent procedures for entry of private producers in the energy sector. The apparent slowdown in the growth of exports is also a cause for concern. However, foreign investment flows have remained buoyant, with net FII inflows exceeding $1 billion in the first quarter of 1996-97. Foreign currency reserves have risen from $17.0 billion at the end of March 1996 to $17.5 billion at the end of June 1996.
5. Though no official estimates are as yet available on savings and investment performance during 1995-96, there are some early indications of likely trends. The continued high growth in capital goods production, the acceleration in the growth of cement production and the higher growth of capital goods imports in 1995-96 suggests that private fixed investment continued to grow strongly in 1995-96. Data on aggregate savings performance is not available and the indications regarding net flow of savings through the financial system is somewhat mixed. While there was continued substantial growth of commercial bank credit to the non-food commercial sector, and gross disbursements by development financial institutions also recorded a sizeable increase of 18 per cent, the amount of capital raised through the primary market issues declined by as much as 24 per cent in 1995-96 and inflows through GDRs were low.
6. The expansion in bank credit to the commercial sector would have been higher but for the continued high levels of borrowing required by the Central Government to finance its fiscal deficit, which exceeded the budget estimate of Rs.57,634 crores and rose to Rs.64,010 crores (RE) in 1995-96. The buoyant demand for investible funds by the private sector combined with continued strong need for borrowings by Government ensured that nominal interest rates remained high despite the decline in the rate of inflation observed during 1995-96. Thus, by the end of the last fiscal year, although the point-to-point rate of annual inflation had dropped below 5 per cent, most banks were still lending to prime customers at interest rates in the range of 17 to 20 per cent. Sooner or later such high real interest rates (in excess of 12 per cent) are likely to hurt the growth of investment and production. The only way to ease the availability of investible funds to producers and investors without risking the resurgence of inflation and pressure on the external sector is to reduce the borrowing requirements of Government, that is, the fiscal deficit.
7. There are also some indications that the slow pace of economic reform in key government-dominated infrastructure sectors, such as electric power, and unresolved problems and constraints in the agricultural sector could undermine the recent pattern of accelerating aggregate economic growth. Since the latter part of 1995-96 and including the first two months of 1996-97, the rate of growth of electricity production has been slowing. The rail and road transport system and port capacities are also under strain. These are areas where economic reforms have been slow to take-off. Similarly, the growth of agriculture and allied sectors which was on the low side at 2.4 per cent in 1995-96, is projected again at 2.3 per cent by CSO for 1996-97 even assuming a normal monsoon. Sustained acceleration in overall GDP growth requires an acceleration in agricultural growth to around 4 percent per year.
8. In a nutshell, sustaining the high growth trajectory attained in the last two years will require compression of the fiscal deficit, quick reforms in critical infrastructure areas, reinvigoration of agricultural growth and continued strength in the external sector.
9. Growth of agricultural crop production, which averaged over 4 per cent per annum during 1992-93 to 1994-95, slowed to 0.9 per cent in 1995-96. Foodgrains production which had risen to a new peak of 191.1 million tonnes in 1994-95 may also be marginally lower at 190.4 million tonnes in 1995-96, because of a decline in wheat output. Public food stocks which peaked at a high of 35.6 million tonnes in July 1995, declined because of open market sales by the Food Corporation of India. In April 1996, at 22.7 million tonnes, they remain, however, over 50 per cent larger than the buffer stock norm. Reform of customs tariffs, trade policy and the exchange rate system have substantially reduced the bias against agriculture and thus improved the relative profitability of agriculture. More directly, increases in procurement and minimum support prices of foodgrains and freeing of some controls on domestic and international trade in agricultural commodities have improved incentives and widened the opportunities open to farmers. During the year 1995-96, 5.6 million tonnes of rice were exported. All this has contributed to an improvement in the terms of trade for agriculture. Studies by the Commission on Agricultural Cost and Prices show that the index of terms of trade (with base 1969-72) improved significantly from 89.9 in 1990-91 to 98.7 in 1994-95.
10. Investment in agriculture remains an area of concern and could be a significant part of the explanation for the recent growth slowdown. Though improved incentives for the agricultural sector as a whole have played a role in generating an average growth in crop production of 3.4 per cent per annum during the past four years, the slowdown of production growth to 0.9 per cent in 1995-96, despite a normal monsoon, is a cause for concern.
11. One significant problem confronting agriculture, namely the distorted pattern of farmgate prices for three kinds of fertilizer (nitrogenous, phosphatic and potassic) was addressed in early July, 1996 through increases in the subsidy (per tonne) of phosphatic and potassic fertilizers. This should help in moving the NPK application pattern from the current distorted ratio of 9:3:1 towards the more ideal pattern of 4:2:1.
12. The strength of industrial growth throughout 1995-96 has been confirmed by data which has become available since the Economic Survey 1995-96 was written. The acceleration in growth has been maintained, with the growth of 9.3 per cent in 1994-95 followed by 12.4 per cent during 1995-96 (April-February, over corresponding period of the previous year). The capital goods sector maintained its position as an important contributor to the industrial surge with a growth rate of 20.4 per cent during 1995-96 (April-February), on top of the 1994-95 growth of 24.9 per cent (Table 3). Industrial growth has not only been high during the last two years but has also been broad-based. In 1994-95, the growth of 9.3 per cent in the general index of industrial production (IIP) was due to a growth of 9.7 per cent in manufacturing, 8.5 per cent in electricity generation and 7.3 per cent in mining and quarrying. During April-February, 1995-96, overall growth of 12.4 per cent was due to a growth of 13.9 per cent in manufacturing, 8.3 per cent in electricity and 7.4 per cent in mining. A similar growth profile is mirrored in the "use-based classification", where this overall growth in April-February, 1995-96 has come from a 20.4 per cent growth in capital goods, 12.9 per cent growth in consumer goods, 9 per cent growth in basic goods and 10.3 per cent in intermediate goods.
13. Though the performance of the core sector, which was quite satisfactory during 1994-95, has been sustained in 1995-96, a few areas of potential concern have emerged. In 1995-96 electricity, coal, steel, cement, crude oil and petroleum products, with a combined weight of 28.8 per cent in IIP, showed a growth rate of 7.7 per cent, compared with 7.8 per cent in 1994-95 (Table 4). Electricity generation grew by 8.2 per cent, crude oil by 7.2 per cent, coal by 6.4 per cent, saleable steel by 8.9 per cent and cement by 11.2 per cent. The rates of growth of coal and cement have accelerated, while those of electricity and crude oil have declined, in both 1995-96 and 1996-97 (April-May). The IIP for electricity generation shows a sharp drop in annual (point-to-point) growth from August-September 1995 onwards, dropping to 5.1 per cent in the third quarter of 1995-96, but recovering marginally to 5.8 per cent in January-February 1996. Electricity generation has continued to decline in 1996-97, with only a 3.6 per cent growth in April-May 1996. Though the deceleration of growth in 1995-96 and 1996-97 is due primarily to reduced hydro-electric generation (-12.5 per cent and -16.2 per cent respectively), this again points to the urgency of power sector reform. Crude oil production actually declined by 7.7 per cent in April-May 1996-97 over the corresponding period of 1995-96. Infrastructure sectors not included in the IIP showed satisfactory performance in 1995-96, with new telephone connections growing by 20.8 per cent, cargo handled at major ports by 9 per cent and revenue generating traffic of the railways by 7 per cent. During 1996-97 (April-May), the growth rates of these sectors have been 16.1 per cent, 11.1 per cent and 7.4 per cent, respectively.
14. Monetary management in 1995-96 achieved the twin objectives of reducing the annual inflation rate and providing credit support for production. Money supply (M3) growth was reduced to 13 per cent in 1995-96 (from 22.3 per cent in 1994-95) taking March 31, 1995 as the base1. The slower monetary expansion is partly attributable to the higher base but also to the unusually slow growth in bank deposits and partly to the decline in reserve money growth to 14.8 per cent (from 22.1 per cent in 1994-95). This deceleration occurred despite a sharp expansion in net RBI credit to Central Government by 25.1 per cent. As a result of rising private demand for credit, banks which had an excess (over SLR requirements) holding of Government and other approved securities, contributed only Rs.14,766 crores to the market borrowing of the Government compared to a contribution of Rs.16,323 crores in 1994-95. This necessitated sizable support by the RBI to market borrowing of the Government, which, in turn, increased the growth of net RBI credit to the Centre. The resulting growth in reserve money would have been much higher but for the reduction in net foreign assets of the RBI associated with the $3.8 billion decline in foreign currency reserves in 1995-96.
15. Slower monetary growth was accompanied by the deceleration in the growth of bank credit to the commercial sector to 15.7 per cent in 1995-96, compared to 23.1 per cent in 1994-95. There was a similar deceleration in the growth of scheduled commercial banks' non-food credit to 21.6 per cent in 1995-96 as compared to 29.8 per cent in the preceding year. Though non-food credit growth slowed down in 1995-96, it still grew much faster than nominal GDP and at least as fast as industrial production in rupee value. The slowdown in non-food bank credit growth in 1995-96 was compounded by a decline in other sources of finance to industry such as primary issues in the domestic equity market and GDR issues in Euro markets. Furthermore, the continued high levels of Government borrowing associated with a large and over-budget fiscal deficit kept credit markets tight and interest rates high throughout the year.
16. The credit policy for 1996-97 has targeted a monetary growth of 15.5 per cent to 16 per cent, based on a target inflation of around 6 per cent and a projected GDP growth of 6 per cent. Since CSO is now projecting higher economic growth at 6.6 per cent in 1996- 97, monetary growth targets may need to be revised upwards a little. Monetary growth during the current financial year has risen gradually, to reach an annual rate of 16.8 per cent by June 7,1996. This has happened despite a halving of the annual rate of reserve money growth from 14.8 per cent at the end of 1995-96 to 7 per cent by June 7, 1996. The reasons for higher monetary growth include a pick up in the growth of bank deposits and cumulative easing of reserve requirements, including a reduction in CRR from 14 per cent last year to 13 per cent on May 11, 1996 (partly offset by rationalisation of export refinance), and further to 12 per cent on July 6, 1996. Non-resident External (Rupee) Deposits have been exempted from CRR obligations since April, 1996.
17. The annual rate of inflation (based on the WPI) declined from 10.4 per cent at the end of 1994-95 to a low of 4.4 per cent at the end of 1995-96. This performance is not only better than the earlier expectations of an inflation rate of 7 per cent to 8 per cent by the end of 1995-96, but also lower than the forecast in the Economic Survey of 1995-96 (6 to 7 per cent). The annual rate of inflation has remained low at 4.2 per cent until June 22, 1996. The success in reducing inflation from an annual rate of 12 per cent in January 1995 to below 5 per cent in January 1996 is attributable to a combination of factors including the deceleration in monetary growth, high levels of open market sales of foodgrains, a liberal import policy, especially for essential commodities, and the surge in domestic supply associated with the acceleration of economic growth to 7 per cent. The delay in adjustment of administered prices also played a role.
18. The deceleration in growth of prices was seen in all the three sub-groups. Primary articles showed an increase of 4.1 per cent in 1995-96 which is one third of the 12.7 per cent rise recorded in the preceding year. Within this sub-group, foodgrain prices rose by 5.6 per cent compared to a substantial rise of 8.6 per cent in the preceding year. Manufactured product prices increased by 4.8 per cent in 1995-96, less than half of last year's 10.7 per cent. Prices of fuel, power, light and lubricants, which showed low increases, will rise sharply in July 1996 as a result of the adjustment in administered prices of petrol, diesel, LPG, ATF etc. By June 22, 1996 the annual growth rate of prices had declined to 3 per cent (provisional) for manufactured goods, but had accelerated to 6.3 per cent (provisional) for primary articles. The lower price increase in manufactures reflects the much smaller proportion of this sector still subject to import-export licensing and quantitative restrictions and underlines the inflation-controlling potential of a more liberal import policy. It should also be noted that the consumer price index (industrial workers) showed an increase of 8.9 per cent in 1995-96, implying an unusually wide divergence between the wholesale price index and the consumer price index.
19. According to normal practice, the Economic Survey preceded the presentation of the Interim-Budget and accounts data for 1994-95 and revised estimates for 1995-96 are available only now for a reassessment of fiscal stabilisation. Over the past five regular budgets the fiscal deficit has declined as a proportion of GDP from 8.3 per cent in 1990- 91 to a revised 5.9 per cent in 1995-96 (Table 5). Much of this decline occurred, however, in the first year. Since then the fiscal deficit has hovered around six per cent of GDP, except for 1993-94 when the fiscal deficit was 7.5 per cent. This borrowing represents the Central Government's draft on the savings available to the economy for productive investment. The 2.4 per cent reduction in the fiscal deficit has been brought about by a sharper 3.2 per cent reduction in the primary deficit (equal to fiscal deficit minus interest payments). The primary deficit represents the effort made by the Government to control the deficit, as interest payments are largely predetermined by past borrowing. Unfortunately, this reduction in the primary deficit has been partly offset by a 0.8 percentage point increase in interest payments as a proportion of GDP. This, in turn, is largely a legacy of preceding primary deficits accumulated as debt. The revenue deficit, on the other hand, has fallen only by 0.4 per cent of GDP over these five budgets, from 3.5 per cent of GDP to 3.1 per cent of GDP and remains too high for comfort.
20. The revised estimates for 1995-96 confirm the success of the strategy of tax reform pursued in the last few years. Elements of the strategy include simple and more economically rational tax structures, lower rates, wider bases and more effective tax administration. Initially, as Table 5 shows, the ratio of gross tax revenues to GDP fell from 10.8 per cent in 1990-91 to 9.5 per cent in 1993-94, after which it recovered to 10.1 per cent in 1995-96 (RE). The recovery in tax revenue collections has been spearheaded by the outstanding performance of direct taxes which increased from 2.1 per cent of GDP in 1990-91 to 3 per cent in 1995-96 (RE), with their share in gross tax collections rising from 19 per cent in 1990-91 to 29 per cent in 1995-96. The average buoyancy of personal income taxes, as measured by the ratio of change in the tax revenue to change in GDP at current prices, has risen from an average of 1.1 in 1986/87 - 1990/91 to 1.5 during 1991/92 - 1995/96 (RE). Similarly, the buoyancy of corporate income tax revenues has risen from an average of 0.8 during 1986/87 - 1990/91 to 1.7 in 1991/92 - 1995/96 (RE). The increasing role of direct taxes and the reduction in dependence on customs duties (Table 5) has enhanced both the equity and efficiency of the tax system as direct taxes are generally favoured as more progressive and customs duties are viewed as trade-distorting.
21. Banking and capital markets are areas in which reforms have continued in 1996 despite political uncertainty and change, reflecting one of the advantages of relatively autonomous regulators (RBI and SEBI). The RBI ushered in significant monetary policy changes and reforms in April and July 1996. Interest rates on domestic bank deposits above one year and on NRER deposits above two years have been de-controlled. The minimum maturity of bank time deposits has been reduced from 46 to 30 days. SLR on outstanding NRER deposits has been reduced from 30 per cent to 25 per cent. Banks are now required to mark to market 50 per cent of their investments in approved securities, up from 40 per cent earlier. The loan component of bank credit has been raised from 40 per cent to 60 per cent of maximum permissible bank finance (MPBF) for those with limits of Rs.20 crores or higher (the remaining 40 per cent stays on a cash-credit system). For those with MPBF limits of Rs.10 to 20 crores the loan component will be 40 per cent. Access to money market mutual funds (MMMFs) has been extended to corporates and others as in the case of other mutual funds. Six institutions have been given approval (effective 1st June, 1996) by RBI to become primary dealers in government securities. SEBI-approved mutual funds dedicated to government securities will receive liquidity support from RBI up to 20% of their investment. Selective credit controls have been relaxed on cotton and kapas, sugar, gur and khandsari in the context of abundant supply. Call money rates which had declined to around 11 per cent after the April, 1996 slack season credit policy, have declined further after the July policy announcements, suggesting an easing of short term liquidity. Forward exchange rates have mirrored this downtrend, reflecting improved expectations about the growth and stability of the economy and foreign exchange markets.
22. The pace of reform in the capital markets has also been maintained in 1996. The SEBI guidelines on primary issues of debt were modified to allow development finance institutions to utilise the funds raised even before the allotment/listing of the instruments. Eligibility norms were introduced to improve the quality of new issues. The track record for public issue of equity or convertible securities was, therefore, modified as follows: (a) a non-manufacturing company must have a three year dividend payment record; (b) a manufacturing company must either meet the dividend condition or have been appraised by a public financial institution/SCB which also takes a 5 per cent share in loan or equity. Extensive reforms in regulations for mutual funds have been proposed in the form of a discussion paper which has been widely discussed and commented upon. Based on these discussions existing regulations will be amended and are likely to be issued shortly.
23. New guidelines were issued for Euro issues in June 1996, carrying forward the process of liberalisation. Banks, Financial Institutions and Non Banking Finance Companies registered with the RBI were permitted access to GDR markets. GDR issue proceeds were permitted to be deployed for investments in joint ventures and wholly- owned subsidiaries in India by parent companies, in addition to end uses earlier allowed. Use of GDR proceeds for investments in stock markets and real estate were expressly banned. The end use restrictions on proceeds of foreign currency convertible bonds (FCCBs) were also liberalized. Under the new guidelines there is no limit on the number of Euro issues a company or group may float. Furthermore, the three year track record requirement of good performance by the issuing company can now be relaxed for financing investments in infrastructure sectors, such as power generation, telecom, petroleum exploration and refining, ports, airports and roads.
24. As shown in Table 6, India's balance of payments has improved considerably since the crisis at the beginning of this decade, when the current account deficit had risen to an unsustainable level of nearly $10 billion (3.2 per cent of GDP) in 1990-91 and foreign currency reserves had fallen to barely two weeks worth of imports at one point in 1991. Highlights of improvements in the external payment situation include:
1. Recovery of export growth from minus 1.1 per cent, in dollar terms, in 1991- 92 to a positive growth in the range of 18 to 20 per cent in each of the last three financial years;
2. Rise in the ratio of exports to imports to the range of 85 to 90 per cent in recent years as compared to only 60 per cent in the latter half of the 1980s;
3. Significant decline in the current account deficit from over 3 per cent of GDP in 1990-91 to much more manageable levels since then;
4. Rapid growth in annual foreign investment flows from less then $100 million in 1990-91 to the range of $4 to $5 billion in the last 3 years (1993-94, 1994-95 and 1995-96); and
5. Recovery of foreign currency reserves from around $1 billion at one point in 1991 to over $20 billion by end March 1995, though followed by a decline to $17 billion by end March 1996. By July 12, 1996 reserves had risen to $17.7 billion. 25. Although export growth remained strong at 21 per cent, in dollar terms, in 1995-96, the balance of payments came under some pressure because of the continuing surge in import growth, higher debt service on external liabilities incurred in earlier years and a decline in net portfolio investments in the form of GDR issues. Non-oil imports (DGCI&S) increased by 30 per cent for the second year in a row, reflecting the strong boom in the industrial sector since 1994-95. In 1995-96 imports of capital goods increased by over 30 per cent and imports of raw materials and components grew by almost 30 per cent, accounting for most of the import growth.
26. The continued high growth of imports in 1995-96 led to a widening of trade and current account deficits and, together with developments on the capital account, resulted in use of foreign currency reserves of nearly $3 billion. (Over the year reserves declined by $3.8 billion after accounting for valuation changes). Furthermore, the pressure on the balance of payments was also manifested in the market determined exchange rate, with the nominal rupee dollar exchange rate depreciating from a monthly average of Rs.31.4 per dollar in July 1995 to Rs.34.4 per dollar in March 1996. There were pronounced bouts of volatility in the foreign exchange market in September-October 1995 and again in January-February 1996. However, following the announcement of corrective measures by the Reserve Bank of India, the foreign exchange market stabilized at around Rs.35 per dollar up to the end of June 1996. It may be noted that with the rupee-dollar exchange rate ruling at around Rs.35.5 per dollar in the second week of July 1996 the rupee still remained appreciated in real effective exchange rate terms (with respect to India's major trading partners and after allowing for higher rates of inflation in India) by about 5 per cent as compared to March 1993 and by about 1 per cent as compared to the average for 1993-94.
27. During the first two months of 1996-97, the DGCI&S data on foreign trade indicate a significant slowing in the growth of both exports and imports. Export growth has slowed to 14.4 per cent, in dollar terms, over the first two months of 1995-96. Import growth has slowed to 23.4 per cent, with non-oil import growth slowing sharply to only 17.2 per cent and oil import growth rising dramatically to nearly 48 per cent in dollar terms. Even allowing for some special short term factors and bunching of oil import payments, it is quite clear that such high growth of the oil import bill could easily place unsustainable pressure on the balance of payments. Recent adjustments in petroleum product prices should help relieve some pressure.
28. To ease Indian industry's access to external funds the Government issued the guidelines for external commercial borrowing in June 1996 by permitting preferential access to development finance institutions, infrastructure sectors and exporters. These measures complement the liberalization of guidelines for Euro issues noted earlier. In addition, the policy stance towards foreign direct investment has also been clarified and strengthened with the restructuring of the Foreign Investment Promotion Board and the decision to establish a Foreign Investment Promotion Council.
29. The economic reforms of the past five years have brought about a strong recovery in the growth of production and employment, restored the health of our external sector and ushered in far-reaching changes in agriculture, industry, the financial sector, capital markets and the tax structure. But a great deal more remains to be done. The Economic Survey, 1995-96 and its two predecessors have clearly outlined the issues and policy priorities confronting the Indian economy. In this brief Update the key challenges and issues are reemphasized.
30. The central challenge facing the government is how to contain the net borrowing requirements of the Central Government, in other words, the fiscal deficit. Past experience has driven home the perils of a high fiscal deficit. Basically, the government's net borrowing requirements (that is, the excess of its expenditures, including net lending, over its non-debt receipts) can be financed from three broad sources:
1. borrowing from the RBI which is tantamount to printing money;
2. borrowing from non-RBI domestic sources such as banks, other financial institutions and individuals; and
3. borrowing from foreign sources such as donor governments and multilateral institutions. 31. Excess borrowing from any of these sources leads to serious economic problems. Too much borrowing from RBI leads to excessive growth of money supply which, in turn, induces high inflation and downward pressure on foreign exchange reserves and the rupee's exchange rate. Too much borrowing from non-RBI domestic sources drives up interest rates and soaks up investible funds which would have otherwise financed production and investment in industry, agriculture, infrastructure and other sectors; thus growth of output and employment are reduced. Too much borrowing from foreign sources adds to external indebtedness and heightens the risk of the kind of external payments problem which plunged the economy into crisis in 1991. Furthermore, excessive borrowing from all sources, taken together, leads to rising interest payments on government's liabilities, reduces spending available for priority social and infrastructure programmes and feeds the need for higher levels of borrowing in future.
32. The rising interest burden could reach an unsustainable level unless efforts are made to contain it through reduction of the fiscal deficit and retirement of a part of the debt. As a proportion of the revenue receipts, interest payments rose from 39 per cent in 1990-91 to 47 per cent in 1995-96. The high growth of revenue expenditure also throws up another challenge. Less money is available for capital expenditure or investment. While the share of revenue expenditure in total Central Government expenditure has increased from 69.8 per cent in 1990-91 to 78.4 per cent in 1995-96, that of capital expenditure has fallen from 30.2 per cent to 21.6 per cent.
33. In every economy there will be subsidies, some visible, some hidden. This will be particularly so in a country where there are a large number of poor people and some goods and services flowing to the poor have to be subsidised. Nevertheless, subsidies must be closely targeted, periodically scrutinised and kept under tight control. The level of major subsidies (mostly in food and fertilizers) increased from Rs.9793 crores in 1991-92 to Rs.12,550 crores in 1995-96.
34. Quite clearly, if we are to successfully pursue the goals of high economic growth, social justice, self-reliance and price stability then every effort must be made to contain the government's fiscal deficit to manageable levels. This essentially involves: raising current revenues through good tax policies, appropriate user charges for services provided by government and public agencies and adequate dividends from government equity in public enterprises; a transparent and well-designed programme of public sector disinvestment; and tight curbs on growth of non-essential or low-priority government expenditures. If we cannot do this we cannot aspire to high growth of employment, quick reduction of poverty, low inflation and a viable external sector.
35. Measures to contain and reduce the fiscal deficit will also promote public savings and, hence, overall domestic savings necessary to sustain high levels of national investment and growth. As the Economic Survey 1995-96 has pointed out "our private saving rates have been comparable to those of high performing East Asian economies. But our record of public savings has been much poorer and needs to be drastically improved." Basically, this involves reduction in revenue deficits of Central and State governments and much better financial performance of public sector enterprises which have been built with huge amounts of public investment.
36. An equally demanding challenge to India's economic development is how to provide adequate and reliable economic infrastructure services at reasonable cost and with sustainable financing and pricing policies. It must be emphasized that unless there are major improvements in this area, the momentum of growth in industry, agriculture and exports can be lost. It is no exaggeration to say that the prospects for India's social and economic development depend crucially on the performance of infrastructure sectors, such as power, roads, railways, ports, irrigation and telecommunications.
37. Bringing about the necessary improvements will entail a paradigm shift from the old public monopoly approach to one in which private providers of infrastructure services are also actively encouraged. A significant start has already been made in encouraging private providers in power, telecommunications, civil aviation, ports and roads. However much remains to be done to develop and implement viable policy frameworks and institutional structures. Independent regulatory authorities have to be established to set appropriate rates, harmonize design standards and specifications and generally promote the public interest. Transparent and workable rules and procedures for private investment and operation have to be clearly set out in each infrastructure sector. Since government-owned entities will continue to be important providers of services in most infrastructure sectors, far-reaching reforms will have to be undertaken to increase the operational efficiency and accountability of these entities and ensure application of commercial principles in their operation and financial management, including tariff policies. In many cases, major institutional reforms will also be necessary.
38. Cost-effective expansion of infrastructure sectors will require massive amounts of long-term finance. This, in turn, will require reforms of insurance and provident fund sectors and suitable policies for rapid and healthy development of markets for long-term bonds. There is also enormous scope for attracting foreign direct investment in infrastructure sectors.
39. Decades of development experience from dozens of other countries confirms our own experience that rapid, broad-based, labour-intensive growth is the surest route to alleviating poverty and giving dignity and voice to the poor. To achieve this kind of growth we need to promote high levels of domestic savings, encourage their allocation to the most productive uses through well developed financial and capital markets, ensure that our foreign trade policy promotes rapid growth of labour-intensive activities and exports in all sectors, (manufacturing, agriculture and services), reduce monopolistic elements in all markets and provide efficient infrastructure and other supporting services to all economic units, especially small scale manufacturers and small holder cultivators.
40. In addition to implementing policies for promoting employment-intensive growth, the government should strengthen programmes for primary education, primary health care, safe drinking water, housing, rural roads, public distribution system and other social services so that they are fully effective in benefitting the poorest segments of society. Such programmes for building the capacities and skills of the poor constitute effective ways of lifting them from poverty. Furthermore, existing special programmes for employment generation and poverty alleviation need to be strengthened and revamped to increase their effectiveness and reduce waste and leakages. Strong government support, financial and administrative, for these programmes is substantially dependent on maintaining rapid and sustained economic growth, which alone can yield the fiscal resources necessary for social and anti-poverty programmes.
41. With two-thirds of India's labour employed in agriculture, successive Economic Surveys have emphasized the crucial importance of broad-based agricultural growth in raising rural living standards, ensuring basic food security for the nation and strengthening the domestic market for industrial and service sectors. Above all, broad- based agricultural growth offers enormous opportunities for alleviating rural poverty through expansion of on-farm and off-farm employment. To succeed in this endeavour public policies for agriculture must continue to reduce the bias against agriculture in the overall incentive framework through reduction of protection to industry and other means, strengthen social and economic infrastructure in rural areas, revamp rural credit delivery systems and find ways to spur quick completion of ongoing irrigation projects. Irrigation and sound water-management practices will become increasingly important to the health of the rural economy as the demand for water outstrips supply. Provision and maintenance of irrigation services must be more responsive to the needs of farmers, especially small holders. At the same time beneficiary farmers must be willing to bear a reasonable proportion of the cost of irrigation services.
42. The search for strategies to accelerate the growth of employment and the rate of poverty reduction must accord due importance to the services sector. All over the world the services sector has become a dominant source of new jobs for both skilled and unskilled labour. We must review and reform policies which today hinder the expansion of job opportunities in key sectors such as construction, retail trade, tourism and a wide range of maintenance services.
43. India's economic development must harness the opportunities provided by international trade, modern technology and world capital markets. China has shown how $30 - $40 billion a year of foreign investment can be effectively harnessed for economic development without compromising sovereignty and national interest. We must swiftly reform our policies to give effect to the goal of attracting $10 billion of foreign direct investment in a year. At the same time we must remember that foreign investment, like all other capital inflows, has to be serviced. And this will require continued strong growth in our exports of goods and services. In the final analysis, policies which ensure sustained and rapid growth of our exports constitute the best guarantee of our self- reliance and the viability of our external sector.
44. To sum up, the potential for sustaining and even improving on the rapid growth of the last two years exists. But to convert this potential into reality we must pursue policies which ensure higher savings and investment, reduction in fiscal deficits at both Central and State levels of government, a sharp increase in investment in and productivity of key infrastructure sectors such as power and a sustained and rapid growth of exports.
