Review of Developments
Economic developments in India in 1998-99 have to be viewed against the backdrop of an exceptionally turbulent and unfavourable international economic environment. The year saw significant declines in the GDP of a number of East Asian Countries (over 15 per cent in Indonesia and 5-7 per cent in S. Korea and Thailand), continuing recession in Japan, severe financial crisis in Russia, unusual volatility in capital and forex markets of industrial countries, continuing drought in capital flows to developing countries and a sharp devaluation in Brazil in January 1999 as a result of capital flight triggered by continuation of unsustainable fiscal weakness. The extension of the East Asian crisis to countries in other continents ensured slowdown of world growth to less than 2 per cent in 1998 with little prospect of recovery in 1999. World trade growth also decelerated sharply, commodity prices fell and deflation affected much of the world economy. India was not wholly immune to these unfavourable developments.
2. The new, 1993-94 based GDP series recently released by the Central Statistical Organisation (CSO) shows that GDP growth decelerated significantly in 1997-98 to 5.0 per cent from 7.8 per cent in 1996-97 (Table 1.2a). The deterioration in growth was perhaps even worse, if one takes into account the fact that fully one percentage point of growth is attributed to the 20 per cent increase in real value added in the public administration and defence sub-sector arising chiefly from pay increases to government servants. The economy recovered to an estimated growth of 5.8 per cent in 1998-99. The recovery, from the cyclical downturn that started towards the end of 1996-97, would have been firmer but for the East Asian crisis and its effect on world import demand and on international capital markets. Domestic uncertainty arising from non-economic factors also played a role in slowing recovery. Inflation rose sharply during 1998-99, because of an exceptional spurt in prices of a handful of agricultural commodities. The pressure from this source has, however, begun to abate during the last quarter of 1998-99. The inflation rate which peaked at 8.8 per cent in late September dropped steeply from December to below 5 per cent in January. Average inflation for the whole of 1998-99 will, however, be higher than the 4.8 per cent registered in 1997-98.
3. The deceleration in the growth of Indias exports (in US dollars) continued for the third year in succession and growth was negative for the first nine months of the year. Imports, on a BOP basis, have decelerated even more sharply, largely because of a decline in the prices of oil and other commodities, but also because of a slow down of non-DGCI&S imports. The current account deficit consequently fell from 1.6 per cent of GDP in 1997-98 to a projected 1.4 per cent of GDP in 1998-99.* Total net capital inflows in 1998-99 are expected to be lower than in 1997-98 as a result of a deceleration in the private inflows. The decline in foreign direct investment (FDI) and commercial borrowing and outflow of portfolio investment by Foreign Institutional Investors (FIIs) had been only partly off set by the inflow under Resurgent India Bonds (RIBs). Despite these trends, foreign currency reserves (exclusive of gold and SDRs) continued to increase in 1998-99, though at a slower rate than in 1997-98. These reserves went up from US $ 26.0 billion at the end of March 1998 to $ 27.4 billion by the end of January, 1999.
4. The marked slowdown in GDP growth in 1997-98 was largely the result of the volatility in agricultural growth, which collapsed to 1.0 per cent in 1997-98 after soaring to 9.4 per cent in 1996-97 (Table 1.2a). This masked the equally sharp slowdown in growth of GDP from manufacturing to 7.7 per cent in 1996-97 (from 15 per cent the year before). This was followed by a more modest decline to 6.8 per cent in 1997-98. Industrial growth, however, remained almost unchanged in 1997-98 as this was compensated by an increase in other sub-sectors. The increase in GDP from public administration and defence, arising from the decisions on the Pay Commission Report, which increased government employees salaries substantially, compensated for the slowdown in growth of other services. The increased salary level of Central government employees since 1997-98 does not seem to have resulted immediately in a proportional increase in consumption. The growth of private domestic consumption (constant price) fell from 6.8 per cent in 1996-97 to 3.9 per cent in 1997-98 (Table 1.2b). The most important proximate factor in the growth slowdown in 1997-98 seems to be agriculture which affected household income, consumption and investment.
5. The recovery in 1998-99 was led by the rebound in agriculture and allied sectors, which is projected by the CSO to grow by 5.3 per cent (Table 1.2a). All other major sectors of the economy, with one exception, are estimated to have decelerated. The growth of GDP from manufacturing has slipped to 5.7 per cent, that from electricity, gas and water supply to 6.3 per cent, and mining to 0.1 per cent. Trade, hotels, transport and communications was the only other category where growth accelerated from 5.7 per cent in 1997-98 to 6.8 per cent in 1998-99.
6. Although data on aggregate demand is not available for 1998-99, demand factors seem to have played a significant role in the slow recovery of manufacturing growth. The East Asian crisis and its reverberations on the world economy were an important reason for the slow recovery in industrial growth and the continuing deceleration in certain sectors. The financial crisis in East Asia and the slowdown in world trade sharply reduced the growth in world demand for many commodities. This contributed importantly to the declining trend in export growth.
7. In addition to the direct impact on exports, the heightened imbalance between world supply and demand put intense competitive pressure on sectors producing homogeneous products. The decline in global prices of oil by 25.7 per cent and of non-fuel commodities by 14.6 per cent in 1998, compared to a growth of 1.1 per cent and 5 per cent respectively in 1997, is one indication of this. The decline in production of mining sector and the slowdown in growth of basic goods and intermediate goods are at least partly a result of these developments in the global economy.
8. Total gross domestic savings declined to 23.1 per cent of GDP in 1997-98 from 24.4 per cent of GDP in 1996-97 (Table 1.3). Public saving contributed 0.5 per cent and Private saving 0.8 per cent of GDP to this decline. Public saving has declined progressively to 1 per cent of GDP from a recent peak of 1.9 per cent in 1995-96. Both household and corporate saving contributed to the decline in private saving rate. The most noteworthy aspect was the one per cent of GDP decline in household physical saving rate. Household financial saving bucked the declining trend in saving rates, by rising to 10.3 per cent of GDP in 1997-98 from 9.8 per cent in 1996-97. This is consistent with the hypothesis that the salary arrears received by central government employees consequent on the Pay Commission decision were largely saved.
9. Real Gross Domestic Capital Formation dropped marginally from 26 per cent of GDP (constant price) in 1996-97 to 25.6 per cent of GDP in 1997-98 (Table 1.4). This level is only 0.1 per cent of GDP lower than the average for 1994-95 to 1997-98, which represented a substantial step up from earlier levels. The main identifiable factor in the decline was the 0.9 per cent of GDP decline in household investment rate to 8.2 per cent of GDP. The decline in household saving in physical form and decline in household investment are perhaps linked to the large fluctuations in agriculture. Corporate investment increased by 1.2 per cent of GDP to 9 per cent, while public investment increased marginally.
10. Somewhat surprisingly real Gross Fixed Capital Formation remained unchanged at 23.6 per cent of GDP, a rate that is higher than the average for the same four years. Despite a drop in the household fixed investment rate to 7.8 per cent of GDP, the continuing up trend in corporate fixed investment kept overall fixed investment rate from falling. Corporate fixed investment increased from 7.9 per cent of GDP in 1995-96 to 8.3 per cent of GDP in 1996-97 and further to 9 per cent of GDP in 1997-98. This suggests that Indian corporate industry is responding to the challenge of domestic and global competition.
11. After a decline in net agricultural output by 1.0 per cent in 1997-98, agricultural value added is expected to rebound by an estimated 5.3 per cent in 1998-99. Indications are that growth rate in production of agriculture would be about 3.9 per cent in 1998-99.
12. Foodgrain production estimated at 192.4 million tonnes in 1997-98 was quite a let down from the preceding years record output of 199.4 million tonnes. Major setbacks were in wheat with production lower by 3.5 million tonnes and coarse cereals with production lower by over 3 million tonnes. The overall prospects of food grain output for 1998-99 are quite good mainly due to Rabi crops sown in November-December 1998. Rabi foodgrain output is likely to be 96.5 million tonnes, which would be higher than Rabi 1997-98 by 5.2 million tonnes. Thus 1998-99 food grain output is expected to be about 195.3 million tonnes.
13. The 1998 monsoon turned out normal as predicted by the Meteorological Department. Despite this, fiscal 1998-99 experienced set- backs related to the weather. The first occurred in May-June when northern India experienced unprecedented heat wave conditions for many days with maximum temperature touching a high of 48°C. This unusual phenomenon caused extreme moisture stress in some crops, particularly fruits and vegetables. Second, there were severe floods and associated damage in Eastern India. The third weather related aberration occurred in late October 1998 when heavy rainfall resulted in damage to standing and matured paddy and cotton crops, as well as to vegetables such as potato and onion.
14. As measured by the Index of Industrial Production (IIP) industrial growth revived slightly to 6.6 per cent in 1997-98 from 5.6 per cent in 1996-97. This revival however faltered in 1998-99. The growth rate for April-December 1998 was only 3.5 per cent, down from a 6.7 per cent for April-December 1997 (Table 1.1). The mining sector (includes crude oil) has witnessed the greatest deceleration in growth, from 5.5 per cent for the first nine months of 1997-98 to 1.1 per cent in 1998-99 (same months). Manufacturing sector growth also fell from 6.9 per cent for the same months of 1997 to 3.7 per cent in 1998. Electricity growth on the other hand, improved from 6 per cent in 1997 to 6.6 per cent in 1998 over the same months.
15. The greatest deceleration in 1998 was in basic goods, from 6.8 per cent growth in April-December 1997 to 1.4 per cent in 1998. The small recovery in consumer goods production from a growth of 5.2 per cent for 1996-97 to 5.7 per cent in 1997-98 was reversed in 1998-99. Consumer goods production increased by only 2.8 per cent during April-December 1998 compared to 4.6 per cent growth during the corresponding period of 1997. Though the recovery in 1997-98 had been led by consumer durables growth from 4.7 per cent in 1996-97 to 7.8 per cent in 1997-98, the reversal in 1998-99 (April-December) was due to a decline in both sub-sectors. Consumer durables growth fell from 6.8 per cent in the first nine months of 1997-98 to 2.3 per cent in the same months of 1998-99 and non-durables growth fell from 4 per cent to 3 per cent.
16. The continuing slowdown in the manufacture of consumer goods suggests that an autonomous slowdown in the growth of private consumption has contributed to slower growth of aggregate demand. The decline in agriculture production affects the demand for industrial goods with a lag. The decline in asset prices, as reflected in stock prices and real estate, have probably brought the wealth effect (on consumption) to Indian shores for the first time. Such negative effects on consumption are common in developed countries but have not previously been attributed to Indian consumers. The earlier boom in Non-bank financial companies (NBFCs) coincided with and was perhaps related to the increase in consumer credit for automobiles and other consumer durables. The subsequent difficulties of NBFCs may have contributed to the slowing of this credit, and consequently a decline in credit-financed consumption.
17. Greater global uncertainty, domestic uncertainty arising from non-economic factors and a heightened appreciation of risk and uncertainty may have also dampened demand. For instance the obverse of the high salaries offered to financial professionals in the boom years is the job uncertainty and job losses which follow in a downturn. This uncertainty combined with poor performance of stock markets since the boom of 1994 and lack of trust in issuing companies and market intermediaries has also led to a shift of retail investors from riskier investments into safe havens like bank deposits and post office saving.
18. The only industrial sub-sector, which bucked the trend of declining growth rates, was capital goods. Though growth in capital goods had declined to 5.2 per cent in 1997-98 (from 9.3 per cent in 1996-97), it seems to have staged a recovery. The growth rate of 9.8 per cent for April-December 1998 was significantly higher than the fairly respectable growth of 6.7 per cent in the corresponding period of 1997.
19. The import of capital goods (machine tools, mechanical and electrical machinery, transport equipment and project goods) in US $ value also increased substantially during April-November 1998. The growth rate of 7 per cent represents a large turn around from the 16.6 per cent fall in the corresponding period of 1997-98. This was despite a decline in foreign direct investment, and net FII outflows during 1998-99. On balance, total domestic investment has probably grown at a faster rate during the first eight months of 1998-99 than in the corresponding months of 1997-98.
20. The Government initiated several reforms for providing a stimulus to industrial growth (Box 1.1). Coal and lignite, petroleum (other than crude) and its distillation products and bulk drugs were delicensed, as was the very important agro-processing industry, sugar. Coal and lignite and mineral oils were de-reserved from exclusive public sector production. The Budget also announced dis-investment of specified portions of equity from select Public Sector Enterprises like GAIL, IOC, CONCOR and VSNL and a separate policy package for the small-scale sector. Nine items (six from farm implements and tools and three from leather) and electronic toys, were removed from the list of industries reserved for exclusive manufacture by the small sector. Companies were permitted to buy-back their own shares subject to restriction of buy-back to 25 per cent of paid-up capital and free reserves. The rules were changed to allow companies to make inter-corporate investments without prior approval of the Government.
21. A special additional duty of 4 per cent was levied on a large number of imports so as to offset the sales tax and other local taxes imposed by the States and provide a level playing field. Special Task Forces were set up by the Government to look into the problems of steel, cement and capital goods industry. As recommended by them, seven imported inputs critical to steel manufacturing have been exempted from special additional duty and import of their seconds and defective have been allowed against specified c.i.f. values. Depreciation norms for income-tax purposes applicable to purchases of commercial vehicles have been relaxed.
22. Foreign investment norms were liberalised further :
23. Infrastructure performance during April-December 1998 has declined as compared to the corresponding period of 1997. Growth of six infrastructure and core industries (electricity generation, coal, steel, crude oil, refinery throughput and cement) decelerated to 2 per cent during April-December, 1998 from 4.1 per cent growth in April-December 1997. Crude oil and steel have displayed negative growth rates. Rates of growth have also declined for coal, refinery throughput and cement in 1998-99. Electricity generation recorded an increased growth rate of 6.6 per cent in April-December 1998 as compared to 5.6 per cent in April-December 1997 (Table 1.5).
24. Growth of sectors such as railways, ports and telecommunications, that do not appear in the IIP, showed divergent trends. Revenue earning goods traffic on railways in April-December 1998 was lower than in April-December 1997. The telecommunications sector, however, maintained the high levels of growth in the current year. The decline in many of these infrastructure and core sub-sectors seems to be primarily due to reduced demand from industry.
25. In keeping with the firm commitment of the government, and the growing consensus, a number of reforms were introduced in infrastructure, with a view to improving quality, availability and viability. These include the following :
26. Fiscal 1997-98 ended with an annual inflation rate of 5.3 per cent (point to point WPI) and an annual 52-week average inflation rate of 4.8 per cent. This decline in inflation from 6.4 per cent (average) in 1996-97 was consistent with increased availability of agricultural goods in the market (lagged supply effect) and lower international prices of imports. The point-to-point annual rate of inflation in the WPI rose during 1998-99 to a peak of 8.8 per cent on September 26. It decelerated thereafter to 4.6 per cent (provisional) on January 30, 1999. The 52-week annual average rate was still about 6.9 per cent. In 1998-99 unexpected supply side effects arising from shortfalls in production of some agricultural commodities were overlaid on the earlier slowdown in aggregate demand. The shortfalls resulted in an unprecedented surge in the price of vegetables, especially onions and potatoes, which overshadowed the price behaviour of other sub sectors.
27. Despite the steep, though temporary, flare up in the overall inflation rate during 1998-99, the underlying inflation rate remained modest. This is indicated by the subdued trends in wholesale prices of manufacturers (accounting for 57 per cent weight in the WPI) which has risen by only 3.4 per cent between end-March 1998 and, January 30, 1999. Fuel and power prices have actually declined over the same period, with the index dropping from 384.1 at the end of March 1998 to 374.1 by January 30, 1999. This contrasts with a rise of 10.2 per cent in the wholesale price index of primary articles over the same period. The steep fall in the rate of growth of primary goods prices, during the last quarter of 1998-99, is also consistent with the proposition of a smaller step-up in underlying inflation.
28. The year-on-year monetary (M3) growth at 19.8 per cent as of January 15, 1999 exceeded the corresponding growth in 1997-98 by 2.9 percentage points. It is also higher than the indicative target set by RBI of 15 to 15.5 per cent for 1998-99, which was explicitly based on a projected real GDP growth rate of 6.5 to 7.0 per cent and an assumed inflation rate of 5 to 6 per cent. Thus, prima-facie it could be argued that monetary policy accommodated the rise in inflation. The presence of excess capacity in the economy as well as the competitive pressure from outside has, however, ensured that the underlying inflation did not rise. It is only sub-sectors that are shielded from competition by internal controls or quantitative restrictions on imports that have seen large increase in price. Some studies have estimated that about three-quarters of agricultural commodities remain on the restricted list of imports. It is therefore not surprising that most of the inflationary surge was in these commodities, and that production shortfalls got translated immediately into price rises.
29. The rate of expansion in reserve money in the current financial year till January 15, 1999 was 10.7 per cent as against 4.1 per cent in the corresponding period of 1997-98. This reflected the sharp increase in the growth of Net RBI credit to the Government (NRCG) in 1998-99. Growth of NRCG accelerated from 2.5 per cent in 1997-98 to 13.4 per cent in 1998-99. This was only partly offset by a fall in the growth of RBIs net foreign exchange assets to 11.4 per cent in 1998-99 from 13.6 per cent in 1997-98. There was a rising trend in the cut-off yield of both 91-day and 364-day Treasury Bills during 1998, which suggests the possibility of crowding out of private credit in the last quarter of 1998-99, despite comfortable liquidity in the system during the first three quarters.
30. Private credit growth remained low during 1998-99, reflecting primarily the relatively low effective demand for funds from the corporate sector. Till January 15, 1999 in the current financial year, non-food credit expanded by 6.8 per cent as against 7.1 per cent in the corresponding period of 1997-98. The total flow of funds comprising non-food credit and investment in debt/equity instruments expanded by 9.7 per cent till January 15, 1999 as against 11.5 per cent in the corresponding period of 1997-98. Though nominal interest rates had fallen in 1997-98 relative to 1996-97, the trend seems to have reversed in 1998-99 (as measured by call money and Treasury bill rates). Real interest rates, however, continued to decline gradually. Thus, the slight rise in nominal rates reflected a partial adjustment to the higher inflation rate during 1998-99. With inflation beginning to subside, the downtrend in real rates may be reversed unless nominal rates fall during 1999.
31. The Monetary and Credit Policy of April 1998 reduced the Bank Rate to 9 per cent. The CRR was reduced to 10 per cent in April 1998 but it was raised to 11 per cent in August 1998 so as to reduce liquidity. This was needed to calm the heightened volatility in the foreign exchange market, following a rise in risk perception of emerging markets (including India) in the immediate aftermath of the Russian economic crisis. To facilitate mobilisation of long term external deposits, the interest rate ceiling on FCNR (B) deposits of one year and above, was raised by 50 basis points and for such deposits below one year and for floating rate deposits, the ceiling was reduced by 25 basis points.
32. Among the liberalisation measures announced in April 1998 were, (a) interest rates on loans upto Rs. 2 lakh were set so as not to exceed PLR applicable to prime borrowers of over Rs. 2 lakh. (b) All advances against term deposits were set at interest rates equal to or less than PLR, and (c) the minimum maturity period of term deposits was reduced from 30 to 15 days.
33. The budget for 1998-99 was formulated in the backdrop of serious fiscal slippage and a deceleration in economic growth. Its objective was, to (a) restore the momentum of industrial growth, (b) ensure macroeconomic stability, (c) raise investment, particularly in infrastructure, (d) provide impetus to social sector development (e) reverse the decline in agriculture production, and (f) calibrate the pace and character of integration with the world economy. The budget announced a modest reduction in the gross fiscal deficit (GFD) from 6.1 per cent of gross domestic product (GDP) in 1997-98 (RE) to 5.6 per cent of GDP in 1998-99 (BE). Consequent to the release of new series of national accounts, the fiscal deficit as a proportion of GDP at current market prices is now placed at 5.5 per cent and 5.1 per cent for 1997-98 (RE) and 1998-99 (BE) respectively (Table 1.6) . The Revenue deficit, which indicates the extent of borrowing required to finance current expenditure, was budgeted at Rs.48068 crore (2.7 per cent of GDP) for 1998-99 compared with Rs. 43686 crore (2.8 per cent of GDP) for 1997-98 (RE). The primary deficit, which is an indicator of current fiscal operations of the Central Government, was estimated at Rs. 16025 crore (0.9 per cent of GDP) for 1998-99 compared with Rs. 20645 crore (1.3 per cent of GDP) attained in 1997-98 (RE).
34. The Central Government finances during the current year continue to be under stress. The fiscal deficit in April-December, 1998 was exacerbated on account of a higher growth in total expenditure at 26 per cent compared with a growth of only 4.7 per cent in total revenue receipts. Thus, preliminary estimates indicate that the fiscal deficit was higher by 77.1 per cent in April-December, 1998 over that in April-December, 1997, and accounted for about 80.7 per cent of the budgeted fiscal deficit for 1998-99. With continuing shortfalls in collections of indirect taxes due to sluggish growth in industrial production and imports, it is unlikely that the year end fiscal deficit would be contained within the budgeted amount.
35. A number of measures were taken to strengthen the infrastructure and rural sectors. The plan outlay for infrastructure (comprising energy, transport and communications) was budgeted to go up by 35 per cent from Rs.45252 crore in 1997-98 (RE) to Rs.61146 crore in 1998-99. National Highways Authority of India (NHAI) was provided Rs.500 crore to catalyse new road projects. To generate funds for development of roads, an additional duty at the rate of one rupee per litre on petrol was introduced. This is expected to garner Rs.790 crore in a year and will entirely go towards augmenting the corpus of NHAI. Housing was another thrust area. The allocation for the Indira Awas Yojna Programme was enhanced to Rs.1600 crore, from Rs.1144 crore in 1997-98 (RE). The budget provided more fiscal concessions to stimulate housing activity and an ordinance was promulgated for repeal of the Urban Land Ceiling Regulation Act.
36. A number of programs were strengthened to enhance agricultural productivity in a sustainable manner. The plan allocation for Watershed Development Programmes was hiked to Rs.677 crore from Rs.517 crore in 1997-98 (RE). The outlay for Accelerated Irrigation Benefit Programme was enhanced by 58 per cent over the 1997-98. Rural Infrastructure Development Fund (RIDF) IV was launched with an enhanced allocation of Rs.3000 crore. The share capital of National Bank for Agriculture and Rural Development (NABARD) was further augmented by Rs.500 crore with a contribution of Rs.100 crore from the budget and Rs.400 crore from RBI. This will enable NABARD to leverage additional resources from the market to meet the credit needs of the agriculture.
37. The Infrastructure Development Finance Company (IDFC) was designated an all India public financial institution with all attendant fiscal incentives, to enhance long-term finance for infrastructure investment in the private sector. As Provident Funds can be an important source of funding for private sector infrastructure projects, the Union Budget has allowed investment up to 10 per cent of the new accretion in private sector securities which have an investment grade rating. Inland waterways and inland ports have also been included in the definition of infrastructure and given associated fiscal incentives of tax holiday. The budget proposed a guarantee scheme to cover the outstanding dues of Central PSUs such as NTPC and Coal India from SEBs. This would enable the former to raise resources either by securitising these debts or directly entering the market for tapping resources.
38. The effort to simplify and widen the personal income tax continued. Two additional presumptive tax indicators were introduced and the ambit of the presumptive tax effort extended from 12 cities to 35 cities. This has been accompanied by making it obligatory for assesses to quote their Permanent Account Number (PAN) or GIR number in respect of certain high value transactions. With a view to simplify the tax return, a one-page tax return called "Saral" was introduced for all non-corporate taxpayers.
39. To encourage industrial activity in backward areas, the tax holiday granted to industrial undertakings located in any industrially backward State or district was extended till March 31, 2000 and for power generating units till March 31, 2003.
40. On the excise side, the process of rationalisation and reduction of duty rates were carried forward so as to ensure convergence towards a mean rate of 18 per cent ad-valorem. Towards this end, an excise duty of 8 per cent was imposed on a number of commodities. With a view to off set the State and Local taxes paid by domestic producers a special additional non-modvatable levy of 8 per cent was imposed on imports, which was subsequently scaled down to 4 per cent. However, this levy excludes a wide range of goods and categories of imports.
41. For the small-scale industries sector the exemption limit for excise purposes was enhanced from Rs.30 lakh to Rs.50 lakh. Furthermore, to reduce litigation in payment of direct and indirect taxes, a new scheme called "Samadhan" was introduced. This would offer waiver of interest, penalty and a part of tax and immunity from prosecution on payment of arrears. The scope of service tax was widened.
42. There has been slow but steady improvement in the performance of public sector banks. The ratio of Non Performing Assets to total advances in respect of public sector banks declined from 17.8 per cent in end 1996-97 to 16.0 per cent in end 1997-98. The ratio of net Non Performing Assets to net advances also declined from 9.2 per cent to 8.2 per cent in 1997-98.
43. Based on the recommendations of the Narasimham Committee (II) on Banking Sector Reforms, the Reserve Bank announced a number of decisions as part of its mid-term review of the monetary and credit policy released on October 30, 1998. These related to phased introduction of risk weight for Government/Approved Securities, risk weight for Government guaranteed advances, general provision for standards assets, higher Capital to Risk-Weighted Assets Ratio (CRAR, 9 per cent) for banks, etc. Based on the recommendations of the Task Force on Non-Banking Finance Companies (NBFCs), deposit acceptance norms have been rationalised by the RBI.
44. Sanctions and Disbursements by All India Financial Institutions continued their strong growth in 1998-99. During April-December 1998 Sanctions grew by 36.9 per cent and Disbursements grew by 12.5 per cent. This growth was consistent with the improved growth of production of capital goods.
45. Capital markets remained subdued during most of the year. Rs. 3929 crore was raised from the Primary Market during April-December, 1998 as against Rs. 3093 crore in the corresponding period of 1997-98. The bulk of the capital raised (nearly eighty per cent) was in the form of bonds, with very little in the form of equity issues. The Sensex, which had risen at the beginning of the year from 3893 on March 31,1998 to over 4200 in April, declined thereafter to 2934 by end-August 1998. It crossed the 3000 mark in September, 1998 but declined to 2878 on October 5, 1998, and remained below 3,000 for nearly three months. The last quarter of 1998-99 has, however, seen a revival, with the Sensex crossing 3400 in January 1999. This is perhaps reflective of the declining level of uncertainty and improved risk perceptions.
46. The SEBI Board accepted most of the recommendations of the "Informal Group on Primary Markets". The recommendations accepted for immediate implementation were,
47. Measures taken to revive the secondary market included,
48. To facilitate flow of funds to the infrastructure sector, the SEBI decided to grant specific relaxation to public issues by infrastructure companies, which are defined under Section 10 (23G) of the Income Tax Act, 1961.
49. Notable developments in the Government securities market include,
50. The East Asian crisis, which continued to deepen and spread in 1998, led to tremendous volatility and uncertainty in global financial markets, and to a re-evaluation of emerging markets as investment destinations. The increased risk aversion of international capital has had an impact on all emerging economies, including to some extent, India. In spite of a turbulent international environment, Indias balance of payments has remained moderately comfortable, with some reserve accumulation. The current account deficit widened to 1.6 per cent of GDP or U.S.$ 6.5 billion in 1997-98. In 1998-99, it is estimated to fall, as a per cent of GDP, below the level in 1997-98. Net capital inflows are expected to be lower in 1998-99 than in 1997-98 as a result of a deceleration in the inflows of foreign direct investment and commercial borrowing and outflow of portfolio investment by FIIs.
51. The trade deficit, on a BOP basis, increased from 3.7 per cent of GDP in 1996-97 to 3.9 per cent in 1997-98, despite the sharp deceleration in import growth. This is attributable to deceleration in export growth, which continued for the third year in succession in 1998-99. Export growth, in BOP terms, slowed from 5.6 per cent in US dollar terms in 1996-97 to 2.1 per cent in 1997-98. Performance continues to be a major source of concern in the current financial year with exports having declined by 2.9 per cent during April-December 1998, compared to a 3.3 per cent growth in the corresponding period of 1997 (DGCI&S data). This data does not include software exports which are shown under invisibles.
52. The weakness in export performance reflects various international and domestic factors, which include:
53. Total imports, on BOP basis, increased by only 4.4 per cent to US$ 51.1 billion in 1997-98 compared to 12.1 per cent growth in 1996-97, while non-oil imports, excluding gold and silver, grew by only 5 per cent in 1997-98. This marked deceleration was due to several factors, including weak domestic demand, lower industrial activity and lower unit values of imports. There has been a further deceleration of imports in the current financial year. Imports during April-December, 1998 increased by 7.1 per cent compared to 7.4 per cent in the corresponding period of 1997-98 (DGCI&S data). This is largely due to a decrease in the dollar value of POL imports by about 26.3 per cent because of continued softening of prices. The increase of 15.7 per cent in non-POL imports over the same period is mainly a result of a shift in imports of gold and silver from baggage channel to the DGCI&S channel. This follows placement of these imports under a liberal import regime in October 1997. Lower international prices of gold in 1998 have also contributed to the increase in overall demand for gold.
54. The slowdown in global growth and international trade has also led to the introduction of protectionist measures in some countries. These have primarily taken the form of non-tariff barriers (NTBs) like more stringent quality, testing and labelling standards and increased investigations of dumping and subsidies. This has contributed to uncertainty in foreign trade and some market disruption.
55. Trade policy reforms have sought to eliminate various impediments to trade and to promote export growth. The EXIM Policy 1997-2002 continues this process. In the light of the continued slowdown in exports, various measures were announced in August/September 1998 which include :
56. In order to promote trade among SAARC countries, India has unilaterally removed all quantitative restrictions on imports of around 2300 items from SAARC countries with effect from August 1, 1998. A free trade agreement was signed between India and Sri-Lanka which will reduce tariff to zero by 2007 on most commodities. This will provide an impetus to the eventual creation of a South Asia Free Trade Area (SAFTA).
57. The net inflow on invisible account has continued to be a major support to the balance of payments. Invisible receipts have shown robust growth, reaching US $ 23.0 billion in 1997-98. This increase has been spurred by increased private transfer receipts, which have grown by 25 per cent per annum from U.S. $ 3.9 billion in 1992-93 to U.S. $ 11.9 billion in 1997-98. Tourism receipts have risen at a rate of 6.8 per cent per annum during the five years ending 1997-98. The receipts under the miscellaneous category in the invisible account, which include software exports rose from U.S. $ 1.4 billion in 1992-93 to U.S.$ 4.0 billion in 1997-98. Software exports continue to show exceptional growth rates, and increased by nearly 60 per cent in 1997-98. The net surplus earned under invisibles, excluding the Indian Development Bonds (IDB) return flow in 1996-97, is estimated to have increased from U.S. $ 9.3 billion in 1996-97 to U.S. $ 9.8 billion in 1997-98, financing about 60 per cent of the trade deficit in the BOP in 1997-98.
58. The capital account in the balance of payments, which had shown an impressive surplus of U.S. $ 10.4 billion in 1997-98, is likely to be lower in 1998-99. Total net capital inflows in 1998-99 are expected to be substantially lower than the levels in 1997-98, if the exceptional inflows under Resurgent India Bonds (RIBs) are excluded. Foreign direct investment (FDI), which had increased by 18.6 per cent in 1997-98, has fallen by 38 per cent in April-December 1998. Portfolio investment has continued to decline from U.S. $ 3.3 billion in 1996-97 to U.S. $ 1.8 billion in 1997-98, to an outflow of $ 0.7 billion in April-December 1998. The significant decline in portfolio investment was partly a result of contagion from the East Asian crisis that affected all emerging markets.
59. The Resurgent India Bonds (RIB) scheme, launched in the current financial year, was open to both NRIs/OCBs. The scheme opened on August 5, 1998 and closed on August 24, 1998, mobilising U.S. $ 4.2 billion. Net inflows under non-resident deposits declined from U.S. $ 3.3 billion in 1996-97 to U.S. $ 1.1 billion in 1997-98. The gross disbursements under external assistance have declined slightly from U.S. $ 3.0 billion in 1996-97 to U.S. $ 2.9 billion in 1997-98. Gross disbursements during April-September 1998 was lower at US $ 830 million compared to US $ 1066 million during the corresponding period of 1997.
60. External Commercial Borrowing (ECB) approvals up to 23.12.98 in 1998-99 have been placed at US $ 3.8 billion compared to U.S. $ 8.7 billion in 1997-98. Disbursements have fallen even more sharply from $ 4 billion in April-September 1997-98 to US $ 1.6 billion in the first half of 1998-99. This is due to the relative unattractiveness of ECB from the perspective of borrowers. The increase in the cost of ECB funds is due to a general increase in the risk premium for emerging market borrowers, downgrading by international credit rating agencies and the rise in forward premia.
61. The ECB guidelines were revised in 1998-99 and include the following changes :
62. The foreign currency assets of the RBI rose from U.S. $ 22.4 billion at the end of March 1997 to U.S. $ 26.0 billion at the end of March 1998. The high surplus in the capital account in 1997-98 outweighed the current account deficit and resulted in an increase in foreign exchange reserves of U.S. $ 3.9 billion. Total foreign exchange reserves (including gold and SDRs) at the end of January 1999 amounted to U.S. $ 30.4 billion, which provides cover for about 7 months of imports in 1998-99.
63. After an 18-month period of stability, the exchange rate of the Rupee against the U.S. dollar came under downward pressure in August 1997, arising mainly from the East Asian crisis. At the end of January 1999, the exchange rate of the Rupee vis-à-vis the U.S. dollar was Rs. 42.50. The movements in the exchange rate have helped to largely correct the relative appreciation of the Rupee in real terms, which will help to offset the competitive disadvantages arising from the extensive depreciation of the East Asian currencies, and is expected to revive our exports and contain import growth.
64. Indias stock of external debt at end-September 1998 stood at U.S. $ 95.2 billion as against U.S. $ 93.9 billion at end-March 1998. The debt service payments, as a ratio of current receipts, continued to improve over the years declining from 30.2 per cent in 1991-92 to 19.5 per cent in 1997-98. The share of short-term debt to total debt declined from 7.2 per cent at end-March 1997 to 5.4 per cent at end-March 1998 and further to 3.7 per cent at end-September 1998. The share of concessional debt has declined from 44.7 per cent in 1996 to 39.3 per cent at end-March 1998 and further to 37.7 per cent at the end of September 1998.
65. The government has relied mainly on three approaches for reduction of poverty and unemployment viz., higher economic growth, anti-poverty and employment programmes and priority to government expenditure on social sectors. The poverty ratio declined from 56.4 per cent in 1973-74 to 37.3 in 1993-94 in rural areas and from 49.0 per cent in 1973-74 to 32.4 per cent in 1993-94 in urban areas. For the country as a whole, the poverty ratio declined from 54.9 per cent in 1973-74 to 36 per cent in 1993-94.
66. The Planning Commission has estimated that, additional employment opportunities of the order of 29.74 million were generated during January 1,1994 to March 31,1997. This implies an average growth rate of employment of 2.47 per cent per annum compared with 2.31 per cent during July 1,1983 to December 31,1993 and 2.32 per cent during January 1,1978 to June 30,1983.
67. The government has decided to set up the Second National Commission on Labour with a view to provide protection to millions of workers. The main focus of the Commission would be to suggest rationalisation of the existing labour laws in the organised sector and an umbrella legislation for ensuring a minimum level of protection to the workers in the unorganised sector.
68. Increased availability of health care and family welfare services has resulted in reduction of all-India death rate, birth rate and infant mortality rate. The crude death rate declined from 14.9 per thousand in 1971 to 9.8 in 1991 and further to 8.9 in 1997. Similarly, the infant mortality rate per thousand declined from 129 in 1971 to 80 in 1991 and further to 71 in 1997. The birth rate per thousand also declined from 36.9 in 1971 to 29.5 in 1991 and further to 27.2 in 1997.
69. Average real wages for unskilled agricultural labour, which reflect the economic conditions of agricultural labourers, have increased by 0.72 per cent in 1995-96 (Agricultural year July to June), 4.67 per cent in 1996-97 and 4.88 per cent in 1997-98. These trends are consistent with the view that more rapid economic growth has brought about an improvement in living standards of people in general.
70. Several anti-poverty measures have been in operation for decades focussing on the poor as the target group viz. welfare of weaker sections, women and children, and a number of special employment programmes for self and wage employment in rural and urban areas. The Central Plan and non-Plan expenditure on social sectors comprise education, health, water supply, sanitation, housing, slum development, social welfare and nutrition, rural employment and minimum basic services. As a ratio to GDP at market prices these expenditures increased to a record high of 1.91 per cent in 1998-99 (BE) as compared to 1.33 per cent in 1991-92 and 1.75 per cent in 1997-98 (RE). The Central Plan allocation for social sectors and programmes show highest growth of about 36 per cent for family welfare and Women and Child Development in 1998-99(BE) over 1997-98 (BE). The outlay for health has gone up by about 25 per cent in 1998-99(BE) over 1997-98 (BE).
71. A countrys environmental problems vary with its stage of development, structure of its economy, production technologies in use and its environmental policies. While some problems may be associated with the lack of economic development (e.g. inadequate sanitation and access to clean drinking water), others are exacerbated by the growth of economic activity (e.g. air and water pollution). Environmental changes may be driven by many factors including economic growth, population growth, urbanisation, intensification of agriculture, rising energy use and transportation. Poverty remains at the root of several environmental problems.
72. Large scale industrialisation, spread of transport, communication and other modern infrastructure combined with the pressure of population growth have added to the difficulties of preserving clean environment and healthy natural resource base. These have been exerting pressure on environment as witnessed in growing evidence of air and water pollution and land degradation. For instance Delhi is now classified as the fourth most polluted city in the world, with a suspended Particulate Matter (SPM) of 145.3 to 929.8 microgrammes/m3 as against a the National ambient air quality standard of 70 to 360 microgrammes/m3. Organic and bacterial pollution continue to be the predominant source of pollution in our aquatic reserves. The forest cover and globally recognised bio-diversity is also under threat.
73. Such degradation imposes a cost on the society, with the burden of such costs being disproportionately high for the poor who live and depend on such natural ecological systems. Such costs need to be explicitly accounted for in economic policy and planning. The challenge of sustainable development remains formidable and requires integration of countrys quest for economic development with its environmental concerns. Choice of policies and investment has to be such which encourage cleaner production/consumption and practices that minimise the environmental impact.
74. The most intractable and long-standing issue confronting us is that of the fiscal prudence. The various aspects of the fiscal problem, namely the fiscal deficit, the revenue deficit, unproductive expenditures and unsustainable subsidies are now fairly well known. With the exception of the initial success achieved in 1991-92 under the pressure of the balance of payments crisis, subsequent improvements have alternated with set backs and reversal. As a result, the position today is not significantly better than in 1991-92. There is therefore a clear need for building a political consensus on this issue in terms of both constitutional and administrative measures that need to be taken.
75. The fiscal deficit is the key parameter of macroeconomic policy, which has profound implications for inflation, interest rates, investment, growth, the financial system, balance of payments and last, but by no means least, overall credibility of Governments macroeconomic policy. For the Central Government the fiscal deficit simply reflects the net borrowing requirement of the Government. A high fiscal deficits leads to excess borrowing from either the RBI or the market for loanable funds. Excessive borrowing from the RBI leads to high monetary growth, which fuels inflation and puts pressure on the exchange rate. When considering Government borrowing from the market, the fiscal deficits of Centre and State Governments need to be aggregated (in 1997-98 (RE) this was 7.4 per cent of GDP). Such a high level of Government borrowing pre-empts funds which could otherwise have been used productively in industry, agriculture and services. High deficits also keep interest rates high and investment and growth low. Excess Government borrowing also places undue pressure on the domestic financial system and capital markets. There is also the long-term issue of sustainability of fiscal deficit.
76. Long term fiscal sustainability generally requires bringing down the Primary deficit (gross fiscal deficit minus interest payments) to below zero. For the Centre and States together, the primary deficit is estimated at 2.4 per cent of GDP in 1997-98 (RE), with little prospect of improvement in 1998-99. A reduction in the primary deficit to zero would, therefore, require at least a 2.4 per cent of GDP reduction in the fiscal deficit. If the entire adjustment falls on the Central government, this would require a reduction of the Central fiscal deficit to about 3.3 per cent of GDP. This target assumes that the real interest rate in the economy is lower than the growth rate. If this condition does not hold for any reason, a primary surplus and consequently a greater reduction in the fiscal deficit would be required.
77. Quite clearly, fiscal consolidation is absolutely necessary for containing inflation, reducing interest rates, promoting investment and growth, and fostering reasonable stability in the financial system and the foreign exchange market. Experience from the rest of the world underlines the importance of fiscal deficit reduction in regard to reducing interest rates and inflation. It is therefore essential to put the fiscal deficit on an irreversible and unambiguously declining trend.
78. In a broader qualitative sense, sustainability also depends on the quality of the government expenditure and the nature of the tax system underpinning the fiscal system. Concern about the revenue deficit stems from the legitimate concern that a significant part of revenue expenditures are of low priority. These low priority expenditures and non-targeted subsidies need to be identified and eliminated. This is also essential for freeing up funds for completing the unfinished tasks of universal primary education, effective public health systems and modern water and sewage systems for the entire population. The impact of the Fifth Pay Commission and its aftermath on revenue deficits of Centre, States and local bodies lends urgency to the need to downsize government. The time has perhaps come to reconsider the issue of constitutional limits on the deficit as well as to take up the challenge of reengineering government.
79. The task of reforming the tax system must also be carried forward and completed. But such reforms must be accompanied by determined efforts to augument revenue mobilization through base broadening, improved administration and other means. The decline in the tax to GDP ratio of recent years must be reversed.
80. The commendable but gargantuan task of decontrol and de-bureaucratisation which every government in the nineties has set for itself remains unfinished. The extent and depth of the economic distortions such controls have created are perhaps still not fully appreciated by all, even though the negative effect on the public is known to all who interact with the government. The remaining price and distribution controls must be eliminated. At the State level this must be preceded by a major effort to identify such controls. Investment controls are the second most pernicious legacy of the control era and remain in several infrastructure service sectors. SSI reservation is another form of investment control. The need to replace all quantitative restrictions by fiscal measures was recognised even in the eighties, yet import and export controls remain widespread in certain sectors like agriculture. Though reform of the foreign exchange system has been one of the prominent areas of reform, the operation of exchange controls still requires improvement, particularly for exporters and knowledge-based industries. Similarly, though some of the well-known financial sector controls have been removed, many controls remain embedded in the laws, rules, regulations, norms and procedures.
81. The very uncertain global environment during 1998 has brought external issues back into focus during 1998-99. As downside risk remains prominent in all the forecasts of the world economy for 1999, the prominence of external issues in our own policy making is likely to continue in the coming year. The deceleration in the growth of exports over the last three years has mirrored to some extent the deceleration in growth of exports from developing countries. It is somewhat disturbing that the deceleration in the dollar value of our exports has been greater than that of developing countries during 1997 and 1998. Though real exchange appreciation since 1996 has contributed to this decline, we have to now go beyond such macroeconomic variables to address the more long-standing and intractable structural disadvantages faced by our exporters (relative to those of exporters in China, Malaysia, and Thailand).
82. During the last two to three decades, the fastest growing economies of the world have also had fast growth of (manufactured) exports and employment. Most of these countries have built a much more positive environment for exports (and investment), than we have been able to do. This has two aspects: a liberal and flexible policy regime for export production and marketing and simplified rules and procedures for exporters. The increased opportunity in the area of software and other service exports and knowledge-based industries has thrown up additional areas for policy reform and procedural simplification.
83. In terms of routine interaction between exporters and the organs of the state, such as customs, exchange control, tax authorities and licensing authorities (DGFT), a sea change in approach is required to bring it on par with successful exporters of East Asia. Even a neighbouring country such as Sri Lanka reportedly has a much friendlier operational environment for exporters than India.
84. The policies applicable to export production need to be transformed to remove the controls and constraints facing exporters. This requires a comprehensive re-examination of labour laws and SSI reservation as applicable to exporters, with a view to bring them on par with successful, exporting countries, like China. Warehousing and cargo handling of imports and exports at airports and ports remains a monopoly of the state, with the consequent deleterious effect on service. The supply of infrastructure services like electricity, telephones and rail transport to exporters, remain of as poor quality as for the general economy. If these policy and procedural steps (along with fiscal correction) are not taken, the balance of payments could again come under pressure. Better export promotion policies also require a clear recognition that high import tariffs discourage exports, while lower tariffs enhance the relative profitability of exports. Greater liberalization of trade in agriculture is also desirable for promoting exports.
85. Radical reforms in the areas of infrastructure services, agriculture and factor markets are necessary to initiate a virtuous cycle of export growth, employment generation and economic growth. With only a year left before the start of the 21st century it is perhaps an appropriate time to start preparing for a second generation of economic reforms. Such a reform agenda must include reform of factor markets, public sector, government and other public institutions, legal systems, State level policies and procedures and reform of critical sectors such as infrastructure, agriculture, education, R&D and agricultural/rural extension.
86. Within factor markets, capital markets and the financial sector have also seen considerable reforms. The financial collapse in East Asia and other countries has, however, emphasized the fact that we still have some way to go in bringing the financial sector (including banking) to international standards. Completion of insurance and pension fund reforms is merely the first step in creating strong and vibrant long-term debt market. Other factor markets areas such as labour, land, natural resources and corporate management have not been tackled seriously by reforms so far.
87. The fact that primary responsibility for social sectors, agriculture and rural development is generally assigned to the States under the Constitution, underlines the importance of state level reforms. These include fiscal reforms, decontrol and de-licensing particularly with respect to transport, storage and processing of agricultural goods, reform of infrastructure sectors like electricity, canals and road transport and decentralisation and involvement of local bodies, including NGOs. Institutional reforms such as those related to size and quality of government, freedom of information, economic laws and the legal system require involvement of the Central and State Governments as well as the judiciary.
88. These reforms have to be designed to set in motion a process of self-sustained, employment promoting growth. Democratic participation and empowerment of the people through education, public health improvement and information/knowledge is an essential element of such growth. Once policy distortions that promote capital intensity or discourage hiring of labour are identified and removed, investment can create more new productive jobs. Government administration and Public institutions will need to be transformed to recognise and appreciate the centrality of efficient investment (physical, human or knowledge capital) in any self-sustaining development process.
89. The award of the Nobel Prize in Economics to Prof. Amartya Sen has again brought home to us (if such a reminder was needed) that growth and development are ultimately about the entitlements of people. Universal literacy and compulsory primary education are necessary not only for sustaining productive employment and economic growth, but also for making every individual a full participant in the democratic life of the nation. The provision of public goods and basic amenities like water, sewage and sanitation must extend not just to the middle class but also to the poorest of the poor. Research & monitoring and control of contagious diseases and epidemics may not be glamourous activities but often have far reaching effect on the poor. Similarly, strengthening of the norms of civil society and elimination of violence and corruption will bring substantial benefits for the poor. It is critically important to refocus government priorities to those areas which are the basic responsibility of government and to withdraw from areas where private initiatives can often achieve the goals more efficiently.