Economic Survey 2004-2005

Economic Survey > General Review > Review of Developments > Issues and priorities


Review of Developments


Issues and priorities

1.64  The encouraging signs of a pick up in investment and acceleration in growth pointed out by the last Survey have strengthened in 2005-06. Investment, as a proportion of GDP (at current prices), increased steadily from 23.0 per cent in 2001-02 to 30.1 per cent in 2004-05.  Its continued buoyancy is manifest in the rapid rate of growth of credit and of production and import of capital goods; number and value of primary issues; and the stock price rally in secondary markets.  Also, with an anticipated growth of 8.1 per cent in 2005-06, the compound average growth rate of the economy is likely to exceed 8.0 per cent in the last three years ending in 2005-06.

1.65  The odds are loaded heavily in favour of a continuation of the growth momentum observed in the last three years.  A virtuous cycle of growth and savings, that appears to be already underway, is likely to continue for some years to come. Household savings rate will increase with accelerating income growth, particularly with the reinforcement of benign demographic dynamics. With the ‘dependency ratio’ on the decline and the growth rate on the rise, the proportion of people in the working age group will not only be higher but will also have much higher incomes to save from than the preceding generations.  Thus, the household savings rate will increase further.  With its well-known ‘home-bias’, domestic savings finances the bulk of domestic investment in any country.  Thus, the investment rate in the Indian economy is likely to rise, pari passu, with rising domestic savings rate in the years to come.  And, rising investment rate will feed back into higher growth, and reinforce the cycle. As the large gap between investment rate in India and that in East Asian countries during their take-off stage gets bridged, Indian economy should start posting growth rates close to the rates observed then in the East Asian countries. 

1.66  The ‘demographic dividend’ will also pay off in terms of a larger and younger labour force gainfully employed in production, and generating a larger national income, particularly in a world where many countries are transiting to ageing societies.  The suggestion by various empirical studies that, given its institutional strengths, India’s per capita income should be four to five times of what it is now, portends a bright outlook for growth over the medium term. The multi-pronged challenge lies in providing an appropriate policy framework to harness the dormant talent pool of Indian work-force and entrepreneurs to position the economy on a sustained high-growth trajectory.

1.67  Speedy provision of quality infrastructure through appropriate policy stimulus constitutes the first and foremost component of this challenge. India’s growth prospects are intricately intertwined with the rapid development of physical infrastructure such as power, roads, ports, and airports, and efficient delivery of such services.

1.68  On an approximate basis, power shortage, at around 12 per cent in peak and 8 per cent in average terms, is equivalent to around 50 billion units, or (at Rs. 3 per unit) Rs. 15,000 crore, of foregone generation from utilities.  The simplistic assumption of 5 per cent power-intensity of aggregate output in the economy yields a supply-multiplier of 20 and an associated GDP-loss of Rs. 3,00,000 crore; but, it disregards the use of alternative – albeit more expensive – energy sources, such as captive power. Nevertheless, inadequate availability of power adversely affects in a major way not only the output of large industries, but also irrigation in agriculture and production of small and medium enterprises.

1.69  A reversal of the slowdown in the mining sector, particularly coal, is critical in this context.  Coal meets about 60 per cent of the country’s total commercial primary energy demand, and generates 70 per cent of all power.  Nationalised during 1971-1973, the coal sector continues to be dominated by central public sector undertakings. During 2004-2005, with output growth of 5.6 per cent, there was a shortage of domestic coal, and several thermal power plants remained at the level of critical supply (3 days’ feed-stock) through the year.  In the current year, while with concerted attempts, including through imports of 10MT (equivalent to 18MT of domestic coal), the availability of coal for thermal plants has improved, the overall problem of shortage persists.  The problem of rigidity of the pricing system that partly led to the shortfall in domestic supply relative to demand and resulted in shortages has been addressed in part by the introduction of e-marketing.  During April-November 2005, Coal India Limited sold 10.2 MT of coal by auction through e-marketing. But, more needs to be done.  There is a need for further liberalization, including: allowing an associated coal mining company engaged in captive mining to sell excess coal to any other eligible end-users; allocating coal blocks for captive mining through price-based auctions; and liberalization of FDI restrictions in joint ventures in captive mining.

1.70  The impact of roads on economic development is well-known.  For example, in Latin America, a ten per cent increase in the length of roads per worker has been estimated to increase GDP per worker by nearly two per cent.  Without adequate roads in India, particularly in rural areas, the objective of agricultural diversification from cereals into perishables such as fruits and vegetables can not be achieved.  Similarly, lack of an enabling infrastructure remains the single most important constraint to export growth.  Achievement of the ambitious export target set in Foreign Trade Policy 2004-09 requires a projected augmentation of the installed capacity of ports by 140 per cent. Indian ports have a vessel turn-around time of 3-5 days as against only 4-6 hours in Singapore and Hong Kong. Improvement of airports, passenger amenities and emphasis on targeted tourist segments need to be vigorously pursued to ensure further sustained boost in the tourism sector.

1.71  The total investment required in infrastructure is enormous.  The Committee on Infrastructure, headed by the Prime Minister, has estimated the investment requirements as: Rs. 1,72,000 crore in the National Highways sector by 2012; Rs. 40,000 crore for Airports by 2010; and Rs. 50,000 crore for Ports by 2012.  A substantial share of this investment is expected to come from the private sector.  India has an estimated potential to absorb US$150 billion of FDI in the next five years in the infrastructure sector alone.  It is important that the India Infrastructure Finance Company Limited (IIFCL), incorporated on January 5, 2006, not only becomes operational but starts lending funds, especially debt of longer term maturity, directly to the eligible projects to supplement other resources from banks and financial institutions from an early date.

1.72  Policies and institutions need to be geared up to meet the specific requirements of the infrastructure sectors in India. A well-defined regulatory architecture has to be in place, to increase the comfort level of the different players in the market.  Issues of span of control, and conflicting domains need to be delineated and fleshed out.  For example, an energy regulator, cutting across line ministries, needs to be in harness to tap the synergy of the different sectors.

1.73  There was a step up in budgetary outlays on roads financed through the enhanced road cess on motor spirit and high speed diesel in 2004-05 and 2005-06. But, the need for faster consolidation as per the FRBMA to open up fiscal space for higher outlays on infrastructure, both physical and social, continues. The Budget for 2005-06 had to take recourse to a temporary pause in the process of fiscal consolidation, which, given the past experience of initial promising starts followed by subsequent set backs, has given rise to apprehensions of a reversal. However, the pause in the revenue deficit is a one-off measure to accommodate demand on resources as explained in the statement of the Finance Minister under section 7 of the FRBMA.  Consolidation would resume in the Budget for 2006-07, and the eventual targets of fiscal and revenue deficits under FRBMA would be met by the terminal year 2008-09.

1.74  Following very low or marginal growth in the preceeding four years, Government final consumption expenditure (GFCE) at 1999-2000 prices grew at 9.2 per cent in 2004-05. This category of consumption expenditure includes all levels of government; Centre, States, local authorities and quasi-government  bodies. After growing slower than its private counterpart successively in each of the preceeding four years, GFCE grew faster than PFCE in 2004-05. This reversal in trend need not necessarily be a source of concern if such an increase in GFCE is due to enhanced outlays on social infrastructure matched by commensurate outcomes. Furthermore, in the aftermath of the implementation of the Fifth Pay Commission's recommendations, the general government's fiscal deficit had increased in each of the five years to reach a peak of 9.9 per cent in 2001-02. With the announcement of the impending constitution of the Sixth Pay Commission, there is need to exercise caution to avoid a repetition of a similar deterioration in the medium term.

1.75  Given the rapid growth of public pension liabilities in recent years, the introduction of the new pension scheme (NPS) based on defined contribution and greater investment choice from January 1, 2004 is a welcome development. Relative to many other countries, India is well-placed, because of its demographic dynamics, for putting in place a robust pension architecture that is equitable and efficient.  Addressing the concerns about the safeguards raised in the Report of the Standing Committee on the Pension Fund Regulatory and Development Authority Bill, submitted to Parliament on July 26, 2005, and the passage of the Bill will lay the institutional foundation for operationalising the NPS.

1.76  While significant progress has been made in the rationalisation of duties, reduction in the rates of taxes and other reforms, including procedural, the reform of the tax system still remains an unfinished task. To be competitive globally, the Indian industry needs to be unburdened from the high levels of taxes and the distortive exemptions that provide perverse incentives. The process of withdrawal or grand-fathering of exemptions is being speeded up and higher revenues have accrued even with unchanged or lower rates. The process of simplification and digitization of tax administration, which has been initiated, remains a pre-requisite for a transparent and hassle-free tax system.

1.77  In fulfillment of the promised mechanism for ensuring value for money in public expenditure in the Budget for 2005-06, an Outcome Budget was presented to the nation on August 25, 2005.  It provides an operational framework through a set of monitorable indicators, and will become effective from the next fiscal year.  Together with the Right to Information Act, it is expected to empower civil society to evaluate the performance through benchmarks of achievement that would emerge from various governance structures across the country.  In this context, it is important to avoid the pitfalls of performance and zero-based budgeting in the past, and follow not only the letter but also the spirit of the Outcome Budget.

1.78  In the context of public finance, appropriate pricing of petroleum products assumes significance, particularly with the petroleum marketing sector dominated by public sector oil companies. The movement towards market-determined pricing in hydrocarbon sector has floundered pending the resolution of the issue of subsidy in domestic LPG and PDS kerosene.  Kerosene prices have remained unchanged since April 1, 2002 despite the unprecedented increase in acquisition cost of crude and costs of refining.

1.79  Customs and excise on petroleum products constitute about 40 per cent of the total customs/excise collections of the Government.  With an equally high sales tax, ranging from 12 per cent to 38 per cent, the tax component of the retail price of petrol and high speed diesel remains high.  This has been further compounded by the duty differential across products, including on the basis of end-use, leading to problems of fuel-switching and other malpractices.  The issue of harmonising state levies on petroleum products is being deliberated by the Empowered Committee of State Finance Ministers on VAT. A Committee on pricing and taxation of petroleum products headed by Dr. C. Rangarajan has recently submitted its recommendations for a new mechanism of pricing that promotes efficiency of the hydrocarbon sector on the one hand, and the concerns of maintaining affordability in prices of cooking fuel for the consumers on the other. With medium-term prospects of crude prices remaining high, the continuance of incomplete pass-throughs is not sustainable without serious consequences to the financial health of oil companies and the exchequer. Besides, the perverse incentives for fuel switching and distortions arising from differential tax rates need to be addressed. The management of the lingering oil crisis requires rapid and bold policy responses with a firm resolve.  

1.80  The 60th NSSO round indicates unemployment rates in January-June 2004 that cause some concerns.  Mandated by the NCMP, the enactment of the National Rural Employment Guarantee Scheme (NREGS) on September 7, 2005 to ensure 100 days of wage employment in a financial year to an adult member of every rural household who demands employment and is willing to do unskilled manual work is a landmark initiative in this context. If efficiently implemented, NREGS will decisively address the unemployment situation in the rural areas and change the poverty scenario in the country in a tangible manner. The choice of projects under the scheme is also crucial to ensure that need based and good quality assets and infrastructure are created in the rural areas. With the NREGS serving as a broad based safety net, the entire gamut of expenditure based on anti-poverty initiatives need to be revisited.  

1.81  Wage employment programmes to provide employment on a day to day basis must get transformed to creation of permanent and quality jobs in the growth sectors and productive processes of the economy. It is in this context that labour reforms to accelerate investment, particularly in industry and export-oriented sectors, remain an unfinished important agenda.  Addressing the underinvestment in IT capital in the domestic economy can enhance productivity and expand the scope for employment. Furthermore, there is need to vigorously pursue the development of the small and medium enterprises (SMEs) by facilitating provision of adequate bank credit and of clusters with adequate infrastructure; and through removal of limitations of scale by rapid removal of items from the ambit of small-scale reservation.  There is a need for a paradigm shift to encourage the banks to look at provision of credit to SME and agriculture more as an opportunity for profit rather than as a social obligation under directed subsidised credit.

1.82  A number of major initiatives have been undertaken in the other areas of social sectors like health and education. The National Rural Health Mission has been launched to bring about a qualitative improvement in the public health care delivery in the rural areas. Allocation for elementary education sector has been increased substantially during the year. It is however important now to shift emphasis and focus attention on the quality of outcome of the various social sector programmes rather than their quantity or coverage. For example, the quality of education being imparted at the elementary level, rather than just access or only enrolment of children in school, needs to be emphasised through appropriate modifications in the guidelines and their implementation. This will ensure that the children passing out of the school system have a better chance of contributing productively to the economy. While universal coverage has been achieved in terms of opening of health centres in most states, the quality of public healthcare services both in the rural and urban areas need urgent improvement.

1.83  Efficient management and delivery of the social sector programmes necessitate adequate capacity building at all levels, decentralisation of implementation and transparency in delivery and accountability of the agencies involved. Evaluation studies repeatedly indicate that only those programmes tend to succeed which have elements of the above critical success parameters. Budget 2005-06 has emphasized that all Plan schemes need to be evaluated once in five years, and only then be eligible for carry forward in the next Plan.

1.84  While the worry about rapidly growing imports and the burgeoning current account deficit appears to be somewhat misplaced, the possible risks to an otherwise rosy outlook arise from: inflation; interest rate; and fiscal stance.  In a capital-scarce economy like India, a current account surplus is symptomatic of insufficient investment. There is clear need to enhance investment. Higher investment is likely to result in higher imports of basic, intermediate and capital goods and trade and current account deficit. Such a deficit, however, is unlikely to pose a balance of payments problem as the commodity composition of non-oil imports, with the exception of gold and silver, is biased in favour of capital and other essential inputs and is likely to add to the export momentum in the future. 

1.85  High and volatile international petroleum prices impart an element of uncertainty in the inflation outlook not only for India but also the world economy.  With increasing dependence on imported crude and growing openness, India is no longer insulated from the rest of the world in price developments. This inflation uncertainty, together with the unresolved global macroeconomic imbalances, casts its shadow on the interest rate scenario. A continued firming up of global interest rates beyond a point poses the risk of dampening the domestic investment boom.

1.86  The fiscal risk, both at the Central and State levels, arise from the argument that the fiscal adjustment process in India has led to expenditure compression of the wrong kind.  It is important to safeguard against this argument as the solution lies in not increasing the deficits, but in meeting squarely the challenge of improving the quality of expenditure. Expansionary fiscal policies of the past have resulted in the present expenditure profile and any solution for correction of the same through higher fiscal deficit is reductionism. Though there is no inviolable penal provision under FRBMA, with a promising economic outlook in a globalised milieu, the nation could ill afford to falter in its fiscal resolve without adverse consequences. The journey for sustained economic growth and stability is a long one and quick fix solutions for higher fiscal deficit to temporarily prop up growth through expansionary policies, albeit in increasing productive capacity, would prove to be counterproductive. Instead, there is much scope for better productivity in expenditure and greater growth dividend through deepening the reform process that could harness higher savings and investment. 




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