October 18, 2009

“India Manages Global Crisis

But Needs Serious Reforms for Sustained Inclusive Growth”

by
Ajay Chhibber and Thangavel Palanivel1

for

Stanford Center for International Development (SCID)

Tenth Annual Conference on Indian Economic Policy Reform

October 21-23, 2009
Stanford University, Landau Economics Building

India’s Economic Reforms: Emerging

Challenges for the Country and the New Government

1
We are very grateful to Barry Eichengreen and Nirvikar Singh and participants at the SCID seminar for
comments.
 Abstract

India has been affected by the global economic crisis but through a
combination of “accidental Keynesianism” with high fiscal deficits even
before the crisis, and swift monetary easing it has managed the global crisis
so far better than was predicted by most experts and international agencies.
India’s trade and financial integration into the global economy- especially
since the mid 1990’s - ensured that a global crisis would affect India.
But India remained much less dependent on exports to the developed
world for the acceleration in its growth and it’s still large state sector often
considered a drag on its economy now turned out to be a benefit. Growth has
decelerated from almost 9% to around 6 % in 2008-10 and this will mean
that some 12 m jobs will be lost and 4-5 million who would have crossed the
poverty line had the GDP growth rate continued at 9 % will remain poor.
But compared to many other developed and developing economies growth
has held up much better.
Certain sectors such as diamond and jewellery, auto parts and
engineering goods, construction have been hit hard and workers in them face
much greater job loss, and declining wages. Quick impact surveys by UNDP
and its partners show that these workers are not being helped by any of the
existing social protection schemes and have received no meaningful help
from existing government programs. The extreme poor in rural areas, even
with their patchy implementation have benefitted from schemes such as the
National Rural Employment Guarantee Scheme (NREGS).
However, such schemes do not help migrant urban workers.
Extending the NREGS scheme to provide cash supplements to casual
workers in urban areas to bring them above the poverty line would be a
sensible addition. India relies heavily on food and fuel subsidies. These no
doubt keep prices stable but are poorly targeted and offer no specific help to
people in an economic crisis. In addition the increase in the conversion of
workers from regular to casual contracts – especially during the crisis as
business try to avoid getting stuck with a large labour force - shows that
rigid labour laws, meant to protect workers, are actually hurting them.
 What is noteworthy is that India’s slowdown started even before the
global crisis raising questions over its ability to now return easily to 9 %
growth without addressing long standing reforms. Moreover, recent rapid
growth did reduce poverty but National Sample Survey data show that India
achieved faster poverty reduction in the period mid 1980-90 when growth
was slower but more equal. Therefore some argue it is time for India to reset
towards a more sustainable, inclusive growth strategy.
While India needs a raft of reforms they cannot all be achieved at one
go. Which ones must therefore be the new government’s focus. Which ones
will bring the biggest immediate benefits. Accelerating road and power
infrastructure, revamping labour laws, better health and education outcomes,
and reversing long term neglect of agriculture and rural areas to help them
gain “connectivity” must in our view be the top priority.
India has embarrassingly poor infrastructure, compared even to most
others at its level of development. A cumbersome land acquisition
framework and poor – and politicised - contract implementation system
make for long delays in infrastructure projects. India managed to change it
telecommunication industry, a task that seemed impossible some two
decades ago. Now the same effort must be made for power, ports and roads.
Very rigid labor laws have ensured that even though wages are low
India has a very capital intensive manufacturing base in the organised sector
and very large part of the work force working as casual or contract labor,
with no protection provided by the rigid labor laws. Vocal unions now
protect the rights of a small section of the work force that have protection
under the rigid labor laws. Without labor reform India’s ability to attract
manufacturing investment remains doubtful and what investment that does
come will ironically choose capital intensive technology hurting
employment– a strange anomaly brought about by laws to protect labour.
India lags behind on education and health indicators – its ranked 134th
on UNDP’s human development index (which measures income, education
and health) – barely above Pakistan, but way behind China and Vietnam.
Recently India has increased spending on education and health but it must
focus on how this money is used. District human development reports show
that district level performance on outcomes remains very uneven. Teachers
do not show up at schools and health centers lack medicines, because of
corruption. A district by district monitoring system based on human
development indicators and accountability is needed to make a difference in
social health and education outcomes.
In the long run India will become more and more urbanised – but
today almost 60 % of India still lives in rural areas. This part of India
sometimes referred to as “Bharat” is being left behind. Agricultural yields in
India are about half of China’s. The government has begun to shift more
resources to rural areas but much more is needed. Rural infrastructure and
connectivity remains very weak especially in a large swath of the country
that has turned increasingly Maoist. As the Prime Minister correctly pointed
out a more “ holistic” approach is needed to ensure that rural India gets
connected by access to roads, energy , telecommunications, and education to
the rest of India and to the rest of the world. A rural revolution in new
technology, horticultural crops and agro-industry is needed to lift the rural
areas out of poverty. Thailand and Vietnam provide useful lessons on how
this could be done.
Of course unwinding the fiscal and monetary stimulus packages
remains a short term concern as inflation begins to rise again and public debt
grows alarmingly. If not managed well, India risks stagflation. Containing
growing subsidies, the rising interest bill while trying to generate funds for
India’s infrastructure and social programs will be a keen challenge. New tax
reforms such as the GST, reducing wasteful expenditure programs must
remain a top priority to reach FRMBA targets over the next few years.
Growing security challenges in India’s neighbourhood will no doubt demand
more and more resources.
The political stability afforded to the current government provides
India a great opportunity to reset towards a more sustainable inclusive
growth path and exploit India’s demographic dividend for a golden era. But
it must now tackle the long-standing reform agenda to make this a reality.
 Table of Contents
Introduction……………………………………………………………………… 1
2. Key Channels of Transmission of Global Crisis to Indian Economy…………. 2
3. Impact of the Crisis on the Real and Fiscal Sectors…………………………… 15
4. Social Impact of the Crisis – Employment, Poverty and Human
Development…………...……………………………………………………… 23
5. Assessing the Response to the Crisis………………………………………….. 33
6. Achieving Inclusive Growth in India………………………………………….. 42
7. Findings and Conclusions……………………………………………………… 51
References………………………………………………………………………… 55

Tables and Charts:

Table 1: Net Capital Flows (US$ billions)……………………………………… 9
Table 2: Growth Rate of gross bank credit by major sectors (%)………………. 14
Table 3: Trends in India’s GDP Growth Rates (at 1999-00 prices)……………. 15
Table 4: India’s GDP growth projections by various agencies…………………. 19
Table 5: Receipts and expenditure of the Central Government………………... 21
Table 6: Employment Projection for India…………………………………….. 28
Table 7: Sector-wise Growth Scenarios (%)…………………………………… 29
Table 8: Sector-wise employment scenarios (million person years)…………… 30
Table 9: Scenarios for the Income growth by Poor and Non-Poor Households… 31
Table 10: Scenarios for Rural and Urban Poverty Incidences………………….. 32
Table 11: Fiscal Stimulus Packages in India…………………………………… 34
Table 12: Demand side growth in GDP, growth contribution and relative
share (figures in per cent at 1999-00 market prices)…………………. 43
Table 13: Sectoral Composition of Growth…………………………………….. 44
Table 14: Poverty and Inequality across Rural and Urban Areas………………. 45
Table of Contents continued:

Chart 1: India’s Trade integration has been more Rapid in the last decade……… 3
Chart 2: India’s Exports dependence on Western Economies has declined……… 3
Chart 3: Growth Rates of Exports and Imports Turned Negative Since Oct 2008.. 6
Chart 4a: Trade Deficits (USD) Increased until 2009/09 Q3…………………….. 7
Chart 4b: Trade Deficits declined in 2009 compared to 2008…………………… 7
Chart 5: Current Account Balance as % GDP has worsened during the first
half of 2008-09, but in the second half it improved……………………. 8
Chart 6: Capital Flows (as % of GDP) have declined since 2007………………. 9
Chart 7: Share Market Indices recovered substantially…………………………. 12
Chart 8: Indian Currency has appreciated until mid 2008, then depreciated during
next 12 months; in recent weeks it is appreciating once again................ 13
Chart 9: Bank Regulatory Capital to Risk-Weighted Assets in India &
Asia are above the level set in the Basel norms……………………….. 13
Chart 10: Decelerating Trends in the growth (% YoY) of industrial
Production has been reversed since April 2009………………………. 16
Chart 11: Growth in the Construction Sector has been decelerating since 2006... 17
Chart 12: India Tourism Sector affected due to the global financial crisis……… 18
Chart 13: Unlike in the past, Government Consumption contributed more to
Growth in 2008-09, but the price consumption is likely to contribute
more to growth in 2009-10 (%)………………………………………. 20
Chart 14: Inflation Rates based on the Wholesale and Consumer Price Indices
moved in the opposite direction in 2009…………………………….. 20
Chart 15: Government’s revenue has declined, while expenditure has
increased in the last two years………………………………………. 22
Table of Contents continued:

Chart 16: RBI Policy Rates have been raised until Aug 2008; after the crisis
set in Sep 2008; they have been reduced substantially………………. 36
Chart 17: Despite dramatic reduction of RBI’s Policy Rates, Commercial
bank’s Benchmark Prime Lending Rate remained high……………… 37
Chart 18: Growth Rate of Money Supply decelerated since 2007 Q1
in India………………………………………………………………. 38
Chart 19: India’s’ GDP Growth has been accelerating over the last six
decades……………………………………………………………….. 42
Chart 20 :Development expenditure (as % of total expenditure)………………………….
45
Chart 21: Declining Trends in India’s Public Expenditure (of the Centre and
States) on Agriculture and Rural Development has been reversed…… 46
Chart 22: India’s Public Expenditure (of the Centre and States) on Social
and Community Services has increased in the last 5 years…………… 47
Chart 23 : Population-wise distribution of gross bank credit (% of total)………………….
49
Chart 24 : Sectoral credit by scheduled commercial banks (% of total)……………………
49
 India Manages Global Crisis
Now Needs Serious Reforms for Sustained Inclusive Growth

Ajay Chhibber and Thangavel Palanivel2

1. Introduction

India is amongst a handful of countries that has managed to grow despite the most serious
global crisis since the Great Depression. The Indian economy has no doubt been affected but
much less so than countries in the developed world and less so than most developing
countries as well. Moreover, India has grown faster than was predicted by all international
and multilateral agencies and many Indian experts. India has also been less affected this time
than it was even during the East Asian financial crisis. Some have argued that India’s more
“gradualist” reforms leading to a less open economy has been one important factor in
reducing its vulnerability to the global crisis. Others have pointed to the fact that India
retained a bigger role for the public sector over large parts of the economy and the financial
sector and therefore it is less affected by a crisis that is largely driven by markets. Some have
gone even further and asserted that the Indian economic model, signified by slower trade and
financial liberalisation, careful privatisation (disinvestment) holds up as an example for many
developing countries to follow. While India’s merchandise exports have suffered, its service
exports have held up, and remittances have increased. Portfolio investment has declined
sharply but FDI has shown remarkable resilience – pointing to investors’ faith in the
economy’s long-term resilience.

India has not responded to the crisis, like many large economies, with a big stimulus
package. Instead it announced a series of piece-meal stimulants. This is because India was
already running a huge fiscal deficit even prior to the crisis in the run-up to the elections.
India therefore was forced to rely much more on monetary policy. The Reserve Bank
reversed monetary tightening of the previous three years very quickly to ease credit growth
and ensure bank liquidity. Nevertheless, even with the smaller fiscal stimulus measures,
India’s fiscal deficit at around 6.8% of GDP has far exceeded the FRBM (Fiscal
Responsibility and Budget Management) targets and could go even higher in response to the
poor monsoon and recent floods. Financing of such large deficits acts as a stimulant a sort of
“accidental Keynesianism “ 3 , but runs the risk of threatening fiscal stability and could
“crowd-out” investment and dampen the recovery. Has India reached that limit? Can it start
getting its fiscal position more secure to build the base for a lasting recovery?

It should be noted that the Indian economy began to slow down as early as 2007 much
before the onset of the global crisis. After growing at an unprecedented rate of around 9% per
annum for the period 2002-2007 (sometimes referred to as the golden turnpike of growth),
the Indian economy slowed down in late 2007 and 2008. Part of the slowdown was policy
induced as the Reserve Bank tried to cool down the overheated economy. But some argue
part of the slowdown in growth was inevitable as the lack of key structural reforms
constrained the continuation of the high growth phase. As India strives to return to the golden

2
Ajay Chhibber is the UN Assistant Secretary General and Assistant Administrator & Regional Director of the
Bureau for Asia and the Pacific, UNDP. Thangavel Palanivel is the Senior Advisor and Programme Coordinator
at the UNDP’s Asia-Pacific Regional Centre in Colombo. The usual disclaimer applies.
3
Grateful to Nirvikar Singh for this idea.
1 

 
turnpike, it must assess the reasons for the slowdown in growth even before the global crisis,
in order to prepare the appropriate package of measures to return to high growth. But
restoring high growth will not be enough if it remains unequal. India must find ways to get
back to more inclusive growth to accelerate poverty reduction. Even a slightly slower but
more equal growth may achieve faster poverty reduction than very high unequal growth of
the type seen in India in this decade. What does India need to not only revive growth but
make growth more inclusive?

This paper examines the impact of the crisis on the economy and vulnerable populations.
It tries to make a quantitative and objective assessment of how well has India managed the
global crisis, which sectors of the economy have been most affected, how have businesses
and workers in these sectors coped with the downturn. It then assesses the effectiveness of
India’s stimulus packages, as well as whether the existing social safety net programmes have
helped those affected by the crisis, and what is needed for India to emerge from this crisis
back to sustained inclusive growth. Given the difficulty of getting new and reliable data to
assess the social impact of the crisis, the study has followed three different approaches:
community-based or location specific rapid impact assessment surveys focusing on
vulnerable sectors/industries; a SAM (Social Accounting Matrix) consisting of 46 sectors;
and an elasticity approach (e.g., poverty and employment elasticity of growth) to project
employment loses as well as the increase in the poverty levels.

This paper is organised as follows: section 2 identifies and analyses various transmission
channels in which the crisis affects the Indian economy particularly trade and financial
channels. Section 3 assesses the impact of the crisis on the real and fiscal sectors such as
growth prospects, level and composition of public expenditure, government revenue, and
budget deficit. Section 4 gauges the impact of the crisis on employment, wages, poverty,
education, health, women and migrant workers by using quick impacts surveys, SAM
modelling and elasticity approaches. Section 5 evaluates the current fiscal stimulus measures
to boost growth and employment as well as social protection measures to face the adverse
impacts of the crisis. Section 6 looks forward at India’s options for more inclusive pro-poor
growth. Section 7 presents key findings and conclusions and policy options India must
address for inclusive growth.

2. Key Channels of Transmission of Global Crisis to Indian Economy

The relative strength of the channels by which the global crisis is transmitted varies from
country to country. It is important to identify the key transmission channels for India that
would enable us to trace the impact of this global crisis on the Indian economy from the
macro level down to the household level. The Indian economy has been progressively
globalizing since the initiation of reforms in the early 1990s. The impact of the recession on
different segments of the Indian economy also varies, for example between the financial and
banking sectors on the one hand, and the real economy on the other. If output declines in
capital-intensive industries, the impact on employment would be limited. By following this
mode of analysis, we can identify the sectors/people that will most likely be affected by the
crisis.

Trade
Trade, an important dimension of global integration, has risen steadily as a proportion
of GDP in India. Chart 1 reveals that India is certainly more integrated into the global
2 

 
economy today than 15 years ago. Exports in goods and services now contribute about one
fourth of Indian GDP, and the share has risen in the last decade - from 10% in 1993 and just
11% in 1998 (during the Asian crisis) to 24% of GDP in 2008. Going by the common
measure of globalisation, India's two-way trade in goods and services (exports plus imports),
as a proportion of GDP, increased from 20% in 1993 to 56% in 2008. The share of India's
merchandise exports plus imports, as %
of GDP, has also increased significantly Chart 1: India's Trade integration has been more Rapid 
in the last decade - from 21% in 1998 to in the Last decade (trade as % of GDP)
35% in 2008. In the Indian context,
trade thus seem to be the main channel 70
by which the crisis in the western 60
50
countries is making its impacts felt. 40
Compared to China and other Asian 30 1993
emerging economies, however, India’s 20
1998
integration with the western economies 10
is relatively lower ( Chart 1). 0 2008
Tot Exp Imp Tot Exp Imp
More recently India has reduced
this dependence on developed country India China
markets and created more sources of
export demand within the developing region through South-South trade. India has lowered its
exports dependence on OECD or
developed economies, and the share has
Chart 2: India's Exports dependence on Western 
declined from 53% in 2000 to 39% in
2007. Within the developed world, the Economies has declined
US has the largest share, but it has 25
declined since the late 1990s - from 20
22% in 1999 to 14% in 2007. The
15
declining share of developed economies
has been replaced by increasing share to 10
OPEC nations and developing 5
economies. Within OPEC the largest
0
increase was with UAE. Within the
1993 1995 1997 1999 2001 2003 2005 2007
developing world, a rise in share is seen
across regions - East Asia, Africa and
US UK UAE China
Latin America. The share of China has
increased sharply from 1.4% in 1999 to
7.9% in 2007.4 This has led to the view that export-led growth can continue to be the strategy
for India, but with a redirection of exports within the region and especially to China. The
optimistic view is that China can continue to generate external demand for countries like
India. However, there are several reasons to consider such a view to be excessively
optimistic. To begin with, China’s exports themselves depend on the status of the developed
economy; moreover, Chinese exports and imports have tended to move together, and this is
largely because an increasing share of exports (more than 60 % in 2007) consists of

4
In terms of sources of imports, OPEC had the highest share (33.2 %) - mainly reflecting oil imports.
China continued to be the single largest source of imports, with a share of 10.7 % in total imports.

3 

 
processing exports, in a process which uses imported raw material and intermediates from
other countries to transform into final goods for export.

What is noteworthy is that while India has reduced its export share to western
economies, China has increased its export share to western countries in the last two decades.
Therefore, the impact of the recession in developed economies on India is expected to be
relatively less dramatic compared to China and other Asian emerging economies. Service
exports have emerged as an important source of foreign exchange and employment
generation in India. Contrary to the general perception of India as the most important service
exporter from developing Asia, China is the largest exporter of commercial services, and also
has been experiencing very rapid rate of growth especially in transport services. To some
extent that is explained by the rapid growth of foreign trade, which would naturally have
required more transport services. But the fast increase in other commercial services exports
by China, at around 22 % per annum in the period 2000-2007, is worth noting. However,
unlike China, which has a net deficit in commercial services, India has a surplus in this
category. Indian service exports are vulnerable to the global crisis because of the significant
reliance on the developed country markets. Around 60 % of India’s software exports are
destined for the US market alone. A significant proportion of that has been to the banking and
financial services industry. The impact of the crisis on this sector, and the subsequent (and
related) protectionist attempts to limit off shoring of services by developed country
companies, are therefore likely to have a clear negative impact on such exports. But a counter
to this is the desire for many companies to use off-shoring as a way to cut costs and deal with
the global recession. It is still too early to tell on balance which direction off-shore souring
will take following the crisis.

One specific element of travel services that has large employment effects is the
tourism industry. The recent years witnessed a substantial increase in international tourism in
India. It is likely that Indian tourism sector is vulnerable to the global crisis because of the
significant reliance on tourism from the developed world.

Financial Channel

Financial flows, another important dimension of global integration, have also risen
steadily as a proportion of GDP in India. There are three main channels for financial
contagion: the asset market channel, the banking channel, and the currency channel. An
economic crisis usually leads to declines in equity indices, depreciation of the domestic
currency, and higher non-performing assets in the credit markets. This could then impact
other economies' financial markets as well. The cross border financial linkages have
increased substantially over the years. The correlation between assets (e.g., decline in equity
markets) has been rising across the world.

India’s financial integration with western economies, particularly with the US, has
increased dramatically over the last decade. Inward FDI has taken off and there is a surge in
outward investment from a very low base, with net FDI continuing to grow at a good pace.
The surge of portfolio investment in recent years also testifies to the growing influence of
global developments on the Indian economy. Capital flows, as a proportion of GDP, have
been on a clear uptrend during this decade.

4 

 
 If we take an expanded measure of globalization, that is the ratio of total external
transactions (gross current account flows plus gross capital flows) to GDP, this ratio has more
than doubled from 46.8 % in 1997-98 to 117.4 % in 2007-08. The Indian corporate sector's
access to external funding has increased markedly in the last five years. During 2003-08, the
share of investment in India's GDP rose by 11 percentage points. Corporate savings financed
roughly half of this, but a significant portion of the balance financing came from external
sources. While funds were available domestically, they were expensive relative to foreign
funding. On the other hand, in a global market awash with liquidity and on the promise of
India's growth potential, foreign investors were willing to take risks and provide funds at a
lower cost. In 2007/08, for example, India received capital inflows amounting to over 9 % of
GDP which indicate the importance of external financing and the depth of India's financial
integration (Subbarao, 2008).

More Indian and Asian money is now invested in western countries than at any point in
history. Indians held more than 2.5% of GDP worth of U.S. Portfolio Securities (both debt
and equities) in 2006 compared to almost negligible in 1994, while the Americans own 5.5%
of GDP worth in Indian Portfolio Securities. Emerging Asia held as much as 28% of GDP
worth of U.S. Portfolio Securities (both debt and equities) in 2006 compared to 10% in 1994.
Similarly, the US owns 13% of GDP worth in Asian Portfolio Securities. The financial
exposure to the US as % of GDP is relatively high for Singapore, Hong Kong (China),
Taiwan (China), China, Korea and Malaysia (Chhibber, Ghosh and Palanivel, 2009). This
shows India compared to other Asian emerging economies is relatively less integrated with
western financial markets. These numbers, nevertheless, are clear evidence of India's
increasing integration with western financial markets over the last 10 years or so.

One major source of financial flows for India has been remittances sent by migrant
workers back to their homes. Short term migration increased rapidly in the last decade,
reflecting the significance of labour-scarce Middle Eastern oil-exporting countries and OECD
countries for both skilled work (ICT and finance sectors) and unskilled work (construction
and care sectors). Remittances has provided crucial foreign exchange and been a major
contributor to India’s balance of payments stability. It has played a significant role in rural
consumption and poverty reduction. The global economic crisis has been widely predicted
(World Bank 2008, 2009; ILO 2008) to change all that, as international migration and
associated remittances generally perceived to be among the first casualties. Since a lot of
recent migration from India has been explicitly short-term, it is expected that when economic
activity slows or contracts in the OECD and OPEC countries, Indian migrant workers are the
first to be laid off and sent home.

Impact of the Crisis on the External and Financial Sectors

Trade flows and current account balance

According to the IMF (2009) and the World Bank (2009), overall demand is expected
to decline substantially across the globe and contract in developed economies. The slackening
growth impulses in the world economy emerging from the global financial crisis continued to
impinge on the world merchandise trade. As per the IMF projections5 (July 2009), world

5
International Monetary Fund, World Economic Outlook Update, July 2009.
5 

 
trade volume (goods and services) is expected to shrink by 12.2 % in 2009 from 2.9 %
growth in 2008. This would lead to lower demand for imports from India and other low
income economies, and as a result, India's exports will be impacted as well. In the previous
section we have seen that as India's export base has shifted from developed to developing
economies, one would expect that Indian exports will be affected relatively less compared to
that of other emerging economies. But India’s exports fell substantially in the last 11 months
due to reduced demand for the nation’s jewellery, clothing and other products. Exports
dropped 33% in April 2009 from a year earlier, 29% in May 2009, 28% both in June and July
2009 and 19% in August 2009. Recent falls are the largest since 1991. Exports fell in August
2009 for the 11 straight-month (Chart 3). What is noteworthy is that the extent of negative
growth is becoming small in the last 2 months.

In the year 2008-09 as a whole (April 2008- March 2009), exports recorded a growth
of 4 % as compared with 23 % in the Chart 3: Growth  Rates of Exports and  Imports 
corresponding period of 2007-08. The Turned Negative Since Oct 2008
collapse of exports is more clearly visible 80
from the growth rates over successive Exports Imports
60
quarters of 2008-09. Exports growth has 40
remained resilient until the second 20
quarter of 2008-09 – 23% and 20% 0
growth during first and the second ‐20
quarters respectively. In the third and
‐40
fourth quarters of 2008-09 exports
‐60
declined by 8 % and 19 % respectively.
2006M11

2007M11

2008M11
2006M1
2006M3
2006M5
2006M7
2006M9

2007M1
2007M3
2007M5
2007M7
2007M9

2008M1
2008M3
2008M5
2008M7
2008M9

2009M1
2009M3
2009M5
2009M7
2009M9
In 2009-10, exports growth has remained
negative (30%) in the first quarter; it is
likely to record a negative growth
(around 22%) in the second quarter as well. It should also be noted that India’s exports
started to decelerate from the second quarter of 2008-09 – perhaps due to the fuel price shock
and tightening monetary policy. The shrinking markets of the economies like US and Europe
due to recession have adversely affected India’s exports from the third quarter of 2008-09.
The exchange rate depreciation and fiscal support provided since September 2008 appears to
be ineffective in stimulating growth in exports, indicating that India’s exports are not very
elastic with respect to exchange rate changes, rather it depends largely on the external
demand.6

The collapse of merchandise exports has more severe than service exports.
Merchandise exports have remained resilient in the first two quarters – 37% and 26% growth
during first and the second quarter in the year 2008-09. In the third quarter of 2008-09
merchandise exports declined by 10.4 % as against an increase of 33.0 % in the

6
Some studies such as Bhagwati and Srinivasan (1975), Wadhwa (1988), Virmani (1991), Joshi and Little
(1994), Krishnamurthy and Pandit (1995), and Srinivasan (1998) provide evidence on price responsiveness of
India’s exports. However, Nayyar (1988), Ghosh (1990), and Sarkar (1994) argue that Indian exports are not
necessarily price responsive. Sinha Roy (2005) shows that turning points in India’s post-reforms export
performance were not often led by the movements in exchange rate. Similarly, Garg and Ramesh (2005) also
found that elasticity of exports with respect to exchange rate in India has been negligible and the exports move
more with the state of the world economy. These studies also establish the importance of various demand and
supply factors determining export performance.

6 

 
corresponding quarter a year ago. Merchandise exports have also declined more sharply in
the fourth quarter 2008-09. All commodities, particularly rice, raw cotton, sugar and
molasses, iron ore, iron and steel, gems and jewellery showed decline with an exception of
engineering goods.

In the year 2008-09 as a whole, imports recorded a growth of 17 % as compared with

30 % in the corresponding period of 2007-08. Imports posted a strong growth in the first two
quarters of 2008-09 due to high fuel prices. Imports increased by 39% in the first quarter and
44% in the second quarter. Unlike exports growth which turned negative in the third quarter,
imports growth has just decelerated (9%). Imports growth turned negative (23%) only in the
fourth quarter of 2008-09. In the first two quarters of current fiscal year 2009-10, imports
growth has remained negative (at about 35%). The decline in imports was the sharpest (35%)
during first quarter of 2009-10 (-39.4 %) in relation to the high growth recorded during the
corresponding quarter (39 %) of 2008-09. The decline in imports was on account of both oil
and non-oil imports, reflecting the decline in the international oil prices and the moderation in
the domestic economic activity, respectively. It seems that import deceleration has followed
the export trend with a lag of three months (Chart 3).

  Chart 4a: Trade Deficits (USD) Incrased until 2008/09 Q3 Chart 4b: Trade Deficits declined in 2009 compared to 2008
2000‐01 2001‐02 2002‐03 2003‐04 2004‐05 2005‐06 2006‐07 2007‐08 2008‐09 Jan Feb Mar Apr May
0
0

‐20 ‐2

‐40 ‐4

‐60 ‐6

‐80 ‐8
2009 2008
‐100 ‐10

‐120 ‐12

The average annual growth rate of exports during 2005-06 to 2007-08 was 25.0 %.
Imports, however, grew even faster at an annual average rate of 29.5 % during 2005-06 to
2007-08. These trends in exports and imports have led to widening of the trade deficit
significantly in these years (Chart 4a). In 2008-09, trade deficits widened to US$119 billion
compared to US$88 billion in 2007-08. India's merchandise trade deficit widened from 7.5 %
of GDP in 2007-08 to 10.1 % in 2008-09. However, lately the trade deficit has begun to
narrow, reflecting the sharper decline in the imports in relation to exports (charts 4b). The
merchandise trade deficit in the first quarter of 2009-10 widened sharply to $26 billion, from
$14.6 billion in the last quarter of 2008-09, but narrowed from $31.4 billion in the
corresponding quarter a year ago.

In India, the current account of the BOP is classified into merchandise (exports and
imports) and invisibles. During the last decade, the current account balance (as a ratio to
GDP) has been fluctuating. This has been driven largely by the goods and services (G&S)
trade balance, with the two having virtually the same pattern. The surplus from factor income

7 

 
including remittances, which fluctuated between 2 % and 3 % of GDP, has helped moderate
the substantial deficit on the trade account. The current account, after being in surplus of 1.4
% of GDP from 2001-02 to 2003-04, reverted to a deficit of 1.1 % of GDP from the year
2004-05 to 2007-08. The lower trade deficit in 2008-09 on account of larger decline in
imports relative to exports coupled with sustained invisibles surplus resulted in a turnaround
in the current account to a modest surplus during the fourth quarter of 2008-09, after
recording deficits for seven consecutive quarters (Chart 5). For the year as a whole, however,
the larger trade deficit mainly due to higher growth in imports relative to exports in the first
three quarters of the year led to a higher current account deficit of 2.6 % of GDP during
2008-09 compared to 1.5 % of GDP observed during 2007-08. What is noteworthy is that the
current account has generally
been characterised by   Chart 5: Current Account Balance as % GDP has
persistence of a high trade worsened during the first half of 2008-09, but in the
second half it improved
deficit and buoyant invisibles 10
surplus (Chart 5).
5
During 2008-09, export
growth, on balance of payments 0
basis, declined to 5.4 % from a
high growth of 28.9 % in 2007- -5
08. Import growth also declined
sharply to 14.3 % from 35.2 % -10

during the same period.

Consequently, on a BOP basis, -15
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4
the trade deficit widened to 2006- 2006- 2006- 2006- 2007- 2007- 2007- 2007- 2008- 2008- 2008- 2008-
07 07 07 07 08 08 08 08 09 09 09 09
10.3 % of GDP in 2008-09
from 7.8 % of GDP in 2007-08 Merchandise Invisibles Total Current Account

(RBI, 2009).

Recent data indicate a bottoming in the falloff in trade flows and marked
improvements in both net capital inflows and foreign exchange reserves. Unlike some other
Asian countries, India saw little improvement in export performance in the first quarter of
FY2009. Exports during the first 5 months of 2009-10 show little differce from the average
of the last five months of 2008-09 and are about 30% below levels seen a year earlier. Still, a
steady improvement was recorded from the April 2009 low of $10.7 billion to 2009 July’s
$13.6 billion. Imports weakened after July 2008 with falling oil prices and slower economic
growth, to touch a low in March 2009 of $15.6 billion. They subsequently rebounded to
$19.6 billion in July 2009, though they remain substantially below year-earlier levels.

Capital Flows and Capital Account Balance

Capital inflows, as a proportion of GDP, were on an uptrend in the last five years.
They reached a peak in mid 2007. Capital inflows were lower at 1.8 % of GDP during 2008-
09 (April-December) due to the global financial crisis (Economic Survey 2009). The
composition of capital flows is changing in the last decade. Among the components of capital
inflows, foreign investment has been a relatively stable component, fluctuating broadly
between 1 % and 2 % of GDP in the 1990s and early 2000s. However, it seems to have
shifted to a higher plane in the last 5 years. On a gross basis, FDI inflows into India increased
from US$ 8.9 billion in 2005-06 to US$ 22.8 billion in 2006-07, to US$ 34.2 billion in 2007-
8 

 
08 and further to US$ 35 billion in 2008-09 (RBI, 2009). Though FDI inflows remained
buoyant during 2008-09, FDI inflows moderated gradually in the subsequent quarters: from
US$ 11.9 billion in the first quarter to US$ 8.8 billion in the second quarter and to US$ 6.3
billion in the third quarter. But in the last quarter (Jan-March 2009) it accelerated to US$ 8.0
billion (Table 1), reflecting confidence in India’s long-term growth prospects. Half of the FDI
inflows in 2008-09 have gone into three
sectors: manufacturing (21.1 %), Chart 6: Capital Flows( as % of GDP) have declined since 2007
financial services (19.4 %) and 16

construction (9.9 %). 14

12

Even as FDI flows into India 10

8
grew substantially, a simultaneous pick
6
up in outward investment moderated the
4
overall net inflows. Outward investment
2
by India increased from less than US$ 0
2.4 billion during 2003-04 and 2004-05 -2
to US$ 15.8 billion in 2006-07 and US$ -4
18.8 billion in 2007-08. In the fiscal Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4
2008-09 FDI outflows from India was 2006 2006 2006 2006 2007 2007 2007 2007 2008 2008 2008 2008

slightly moderated to US$ 17.5 billion FDI Portfolio Investment Loans Total Capital Account
(Table 1). What is noteworthy is that
overseas investment by the Indian corporates has been much higher in the last two quarters of
2008-09 (US$ 10.7 billion) against in the first two quarters (US$ 6.8 billion) indicating the
Indian corporates’ like their Chinese counterparts are trying to use the crisis as an opportunity
to expand their operations in offshore markets to withstand the global competition, while
benefitting from the lower valuations of assets on account of the crisis (RBI 2009).
Notwithstanding a steady rise in overseas investment by the Indian corporates, overall net
FDI inflows increased from US$ 15.4 billion in 2007-08 to US$ 17.5 in 2008-09.

Table 1 : Net Capital Flows (US $ billions) 

Item April-March 2008-09 P
  2007-08 PR 2008-09 P Apr-Jun. Jul‐Sept.  Oct-Dec  Jan‐Mar 
1. Foreign Direct Investment (FDI) 15.4 17.5 9.0 4.9 0.4 3.2
Inward FDI 34.2 35.0 11.9 8.8 6.3 8.0
Outward FDI 18.8 17.5 2.9 3.9 5.9 4.8
2. Portfolio Investment 29.6 -14.0 -4.2 -1.3 -5.8 -2.7
FIIs 20.3 -15.0 -5.2 -1.4 -5.8 -2.6
3. External Assistance 2.1 2.6 0.4 0.5 1.0 0.8
4. External Commercial Borrowings 22.6 8.2 1.5 1.7 3.9 1.1
5. NRI Deposits 0.2 4.3 0.8 0.3 1.0 2.2
6. Banking Capital excluding NRI deposits 11.6 -7.7 1.9 1.9 -6.0 -5.4
7. Short-term Trade Credits 17.2 -5.8 2.4 1.3 -4.0 -5.5
8. Rupee Debt Service -0.1 -0.1 -0.03 - - -0.07
9. Other Capital 9.5 4.2 -0.5 -1.6 5.2 1.1
Total 108.0 9.1 11.1 7.6 -4.3 -5.3
P: Preliminary. PR: Partially Revised. 
Source: RBI, 2009
9 

 
 India has also witnessed over a decade of portfolio inflows and with each passing
year, portfolio inflows have gained in their significance and have played a key role in the
overall Indian economy. For the period 1992 to 2008, more than 50 % of foreign investment
in India came in the form of Foreign Portfolio Investment (FPI). Although investments by
foreign institutional investors (FII) are typically synonymous with portfolio investments in
India, investments in ADRs / GDRs and offshore funds are also included in any analysis
relating to portfolio flows. Compared with many other emerging markets, portfolio flows
into India have relatively low volatility. India has also not witnessed sharp portfolio
outflows, and with the exception of 1998-99 (following India's nuclear tests and volatility in
the rupee/dollar exchange rate), net inflows have been positive each year. In fact, domestic
political events or external shocks have tended to be mild and short lived, indicating to an
extent the sustainability of the Indian economy.

The trends in foreign portfolio investments (mostly FIIs) are quite different from FDI
trends in the crisis period. During 2008-09, portfolio investment witnessed large net outflows
due to large sales of equities by FIIs in the Indian stock market, reflecting panic situations
following global financial crisis. It witnessed an outflow of US$ 14 billion in 2008-09 from
inflow of US$ 29.6 billion in 2007-08. Quarter-wise data for 2008-09 show that portfolio
investments posted outflows for all four quarters: outflow of US$ 4.2 billion in the first
quarter, US$ 1.3 billion in the second quarter, US$ 5.8 billion in the third quarter and US$
2.7 billion in the fourth quarter (Table 1). It implies that outflow has started even before the
financial crisis, though the crisis increased outflows in the second half of 2008-09.

But the latest data on FDI and FPI shows that there is a sharp reverse in the trend. As
against a flow of nearly $3 billion in the preceding quarter of January-March 2009, the direct
and portfolio investments flow together rose sharply to $15 billion during April-June 2009.
Of the total investment flows during the quarter, portfolio investments accounted for $8.3
billion, while direct inflows contributed $7.0 billion to the total flows (RBI, 2009). Signs of
India’s economic recovery appear to have raised the confidence among foreign investors with
the flow of foreign investment surging five times in the April-June 2009 quarter compared to
previous quarter.

Like foreign portfolio investments, funds raised by Indian business as external

commercial borrowings (ECB) declined by 64 % during 2008-09 on account of tight liquidity
in the global markets triggered by collapse of Lehman Brothers. The biggest slump in India
came in the external commercial borrowings of corporates as demand declined and
investment plans took a back seat. ECBs came down to almost one-third in 2008-09
compared with inflows in 2007-08. Net ECB flows stood at $8.2 billion in 2008-09 as against
$22.6 billion in 2007-08 (Table 1). ECBs funds also became expensive on account of tight
liquidity conditions in the international financial markets. In spite of high spreads and
increased uncertainty with external borrowing, it has not completely dried out. However, the
major change has been in the purpose of such borrowing. Whereas during 2006 and 2007,
about 40 % of ECBs were made to finance new projects or for modernization of projects, in
2008-09, only 10 % of the money is raised for these purposes. On the other hand, about 70 %
of ECBs are used for imports of capital goods during 2008-09and very little was used to
finance working capital.

10 

 
 The confidence of non-resident Indians in the Indian economy seems to be reviving
again. Non-resident Indian (NRI) deposits with banks surged by $1.8 billion in the first
quarter of FY2010 as against $0.8 billion in the corresponding quarter last year (RBI 2009).
This shows that overseas Indians continue to set great store by deposits with banks in India.
Notwithstanding higher net inflows under the NRI deposits in response to hikes in ceiling
interest rates on such deposits, banking capital flows turned negative during 2008-09.
Banking capital, excluding NRI deposits recorded an outflow of USD 7.7 billion in 2008-09
mainly on account of outflows under overseas borrowings and foreign assets of commercial
banks, while there was a net inflow of USD 11.6 billion under this head in 2007-08. Short-
term trade credit flows turned negative at USD 5.8 billion as compared with an inflow of
USD 17.2 billion a year ago. According to RBI, financing of short-term trade credit did not
pose any significant problem in India, contrary to market perceptions prevailing at some point
(RBI, 2009).

At the same time, India's external debt rose marginally by 2.4 % at USD 230 billion
during 2008-09 against 31 % in the previous fiscal. External debt stock recorded an increase
of USD 5.3 billion (2.4 %) during 2008-09 as compared with an increase of USD 53.2 billion
(31.1 %) during 2007-08. The lower rate of rise in India's external debt during 2008-09 was
on account of valuation effect attributed to appreciation of the US dollar vis-à-vis other major
international currencies, and moderation in debt components, particularly commercial
borrowings and short-term trade credits reflecting the impact of tightness in international
capital markets due to the crisis. The government (Sovereign) external debt declined to USD
54.9 billion as at end-March 2009 from USD 56.9 billion at end-March 2008. Its share in
total external debt was lower at 23.9 % as at end-March 2009 (25.4 % at end-March 2008).
The government debt and government guaranteed debt aggregated to USD 61.7 billion at
end-March 2009, accounting for 26.8 % of total external debt. The depreciation in the Rupee
exchange rate against major international currencies in 2008-09 resulted in higher debt
service payments in Rupee terms. A picture of India's external debt compared with other
developing countries for the year 2007, as brought out by the World Bank’s Global
Development Finance, 2009 indicates that India was the fifth most indebted country amongst
the top 20 debtor countries of the developing world in 2007. However, the ratio of India’s
external debt stock to gross national income (GNI) at 18.9 % was the sixth lowest, with China
having the lowest ratio of external debt to GNI at 11.6 %. In terms of foreign exchange cover
of external debt, India’s position was the fifth highest at 125.2 % after China, Malaysia,
Thailand and Russia (GOI, India's External Debt: A Status Report, Ministry of Finance,
2009).

Recent data indicate a substantial improvement in the overall balance of payments

compared to the situation in 2008-09. For example, in the first quarter of 2009-10, portfolio
investment has recorded a sharp turnaround with a net inflow of $8.3 billion compared with
net quarterly outflows in 2008-09 that averaged $3.5 billion. Foreign direct investment at
$7.1 billion in the same quarter essentially maintained the previous year’s solid performance.
Non-resident Indian deposits have been boosted by RBI’s upward adjustments in interest
rates for such savings. Foreign exchange reserves increased by $12.6 billion in the first
quarter and to $19.5 billion in the first 5 months of FY2009-10 (compared with a $13 billion
fall in the same period the previous year). This turn around could be attributed to relatively
better macroeconomic performance of India during 2008-09 on the back of various fiscal and
monetary stimulus measures as also the positive perceptions of global investors about India's
growth potential.
11 

 
Equity markets collapsed in 2008, but recovered substantially in 2009

In India, stock markets are

an important instrument of financial Chart 7: Share Market Indices recovered substantially
intermediation. India’s global 25000
CHINA INDIA
financial integration had put major 20000
stress on its foreign exchange and 15000
the stock market. The crisis caused
10000
rapid capital outflows, mainly short-
5000
term portfolio investments. In India,
equity markets are the most affected 0

amongst various financial markets.

From highs in Sep-Dec 2007 the
BSE index has declined
substantially during Sep –Dec 2008.
Share prices in dollar terms have fallen by an average of two-thirds from their peak in 2007.
In 2008 alone, Indian equity markets plunged by more than 50%. India does not have a well-
developed corporate bond market and relies on equity markets and bank financing for
external capital. A decline in equity markets adversely affected the investment in the
economy. Since India’s growth has been investment-driven and a decline in investment
impacted growth prospects further. The decline in equity indices was first seen in share prices
of banks and financial intermediaries, as there were fears over the quality of their
international assets. Indian banks had negligible international exposure, although there were
concerns. This then impacted the share prices of other companies. In recent months, there has
been quite a substantial recovery in equities (Chart 7).

In 2009, the BSE index participated in a worldwide rally in equities, and was up by
about 90% - from average of 8892 in Feb 2009 to around 17125 by end of Sep 2009. This is
higher than Chinees SSE index which was up only 51% in 2009. Apart from a reduction in
risk aversion by global investors and an upturn in portfolio investment, the market has
benefited from a general renewal of Indian investors’ confidence based on expectations of
strengthened economic policies based on an enlarged and more cohesive coalition majority in
Parliament, reduced stress on financial markets with easing of credit availability, and strong
financial performance of the corporate sector in the first half of 2009-10.

12 

 
The Rupee weakened significantly, but now seems to have stabilised

Because of capital flight to safety the rupee came under tremendous depreciation
pressure in the post September 2008 period. Chart 8: Indian Currency has appreciated  until mid 2008, then 
As a result, the Indian Rupee and other Asian depreciated during next 12 months; In recent weeks it is appreciating 
once again. 
currencies depreciated substantially and the
Indian rupee touched all time lows. The 55 INR/USD
Rupee depreciated from Rs.39.89 to 50.53 50
per US dollar during 2008-09. It weakened 45
by about 25 % within the span of a few
40
months in 2008. The exchange rate was
highly volatile during 2008-09. After 35
experiencing volatility following the
international financial turmoil, the exchange
rate appears to be currently relatively stable
in the range of 45 and 49. The decline in
export earnings and the outflow of short term foreign institutional investments seems to be
increasing the pressure on the Rupee in the short term. However, with the recent policy
measures such as relaxation of ECB and FDI norms, which have resulted in a surge in the
FDIs and more foreign capital inflow in recent months, we expect that the Rupee will not
depreciate further; in fact, as we see in the last few months, it is likely that it could appreciate
once again (chart 8). During the first 5 months of current fiscal year 2009-10, the rupee - US
dollar exchange rate appreciated by about 4.4%. This reflected renewed capital inflows. The
authorities are likely to resist further strengthening in the rupee given the continued weakness
in exports although the price elasticity of exports is low.

Limited impact on the Banking System and Credit Markets

The Indian banking system is not directly exposed to sub-prime mortgage assets. It
has very limited exposure to the US mortgage market. Indian banks are financially sound,
well capitalised and well regulated. The average capital to risk-weighted assets ratio (CRAR)
for the Indian banking system was over 13%, as against the regulatory minimum of 9% and
the Basel norm of 8% (Chart 9). The CRAR during 2007-08 increased from 12.3 % as of
end-March 2007 to 13.0 % as of end-
March 2008. CRAR for foreign and new Chart 9: Bank Regulatory Capital to Risk‐Weighted Assets in India & Asia 
private sector banks was at 13.1 % and are above the level set in the Basel norms
14.4 % respectively as of end-March 2008
20
compared to 12.4 % and 12.0 %
respectively as of end-March 2007 China 
15
(Economic Survey, 2009). Consequently, India
banks and other financial institutions in Korea
10
%

India and other Asian countries have

Malaysia
escaped from the global financial
turbulence. This is because, thanks to 5 Philippines
Asian financial crisis in the late 1990s, Singapore
Asian banks now have better supervisory 0 Thailand
and regulatory mechanisms. Moreover, 2003 2004 2005 2006 2007 2008
Asian banks have only limited exposure to
US sub-prime related products.
13 

 
 Credit in the last four years has Table 2: Growth Rate of gross bank credit by major
grown above 20%, which indicates sectors (%)
credit markets have expanded 2007- 2008-
manifold and banks have become Sectors 08 09
more aggressive and expanded credit 1 Agriculture & Allied Activities 19.5 23.0
portfolios. The bank credit to the 2 Industry (Small, Medium & Large) 24.3 21.6
commercial sector witnessed strong of which, Small Enterprises 65.2 31.9
growth in the first half of 2008-09; it 3 Personal Loans 12.1 10.8
decelerated sharply in the second half Housing 11.6 7.4
of 2008-09. For the full year 2008-09, 4 Services 31.5 16.9
bank credit to the commercial sector
Transport Operators 33.5 3.9
expanded by 16.9 % only, as
compared to a growth of 21.0 % in Real Estate Loans 43.6 44.6
Non-Banking Financial
2007-08 (Economic Survey 2009). Companies 61.5 25.1
While loans to agriculture & allied Total - Non-food gross bank credit
activities witnessed an accelerated (1 to 4) 22.3 18.1
growth at the rate of 23.0 % during Source: Economic Survey 2009
2008-09 compared to 19.5 % during
2007-08, credit to industry (comprising of large, medium and small scale sector) decelerated
to 21.6 % in 2008-09 from 24.3 % recorded in 2007-08. It may be noted that credit growth
picking up again in recent months based on improved business confidence and strong
financial performance of the corporate sector in the first quarter of 2009-10.

14 

 
3. Impact of the Crisis on the Real and Fiscal Sectors

The Indian economy has been growing at a robust growth of around 8.8% (average) for
the past five years (2003-04 to 2007-08). India was the second fastest growing economy in
the world after China. As in most other developing countries, the global financial crisis
slowed economic growth significantly in India. The recent data show that the Indian economy
slowed down to 6.7% in 2008-09 from 9.0 % observed in 2007-08 (table 3). This represents a
decline of 2.3 % from the last year growth rate, and 2.1 % from the average growth rate in the
previous five years. In 2008-09, an expansionary fiscal policy underpinned the economy.
Government consumption expenditure increased by 20.2%, contributing almost one third of
GDP growth.

At the sector level, the decline was especially evident in an industrial slump in the third
and fourth quarters of 2008-09. The industrial sector growth decelerated from 7.4% in 2007-
08 to 2.6% in 2008-09. The service sector is yet to show sharp deceleration compared to the
industrial sector. With the fiscal stimulus packages and expansion in the fiscal deficit, the
growth in the service sector was relatively strong. This is reflected in 13.1% growth in
“community, social and personnel services”. But nevertheless it also decelerated from 10.8 %
in 2007-08 to 9.4 % in 2008-09. In addition, the growth in the agriculture sector decelerated
sharply from 4.9 % to 1.6 % for the same period (Table 3). Though this is the lowest in the
past five years, this is mainly due to high base level of agricultural output in 2007-08.

Table 3: Trends in India’s GDP Growth Rates (at 1999-00 prices)

2002- 2003- 2004-05 2005-06 2006-07 2007-08 2008-09 2008-09 2009-10
03 04 QE RE Q1 Q1
Sectors

1) Agriculture and its Allied Activities -7.2 9.96 3.9 6.0 2.7 4.9 1.6 3.0 2.4

2) Industry 6.8 6.0 7.6 8.0 10.6 7.4 2.6 5.1 4.2
Mining & Quarrying 8.9 3.1 0.9 3.6 5.7 3.3 3.6 4.6 7.9
Manufacturing 6.8 6.6 9.0 9.1 12.0 8.2 2.4 5.5 3.4
Electricity, Gas & Water Supply 4.8 4.8 5.3 5.3 6.0 5.3 3.4 2.7 6.2

3) Services 7.5 8.8 10.3 10.3 11.2 10.8 9.4 10.0 7.7

Trade, Hotels, Restaurants and 9.4 12.0 11.5 10.4 11.8 12.4 9.0 13.0 8.1
Business services

Financing, Insurance, and real estate 7.98 5.6 9.7 10.9 13.9 11.7 7.8 6.9 8.1

Community, Social and Personal

service 3.9 5.4 7.8 7.7 6.9 6.8 13.1 8.2 6.8

Construction
7.9 12.0 12.1 14.2 12.0 10.1 7.2 8.4 7.1
4) Real GDP at Factor cost 3.8 8.5 8.4 9.0 9.6 9.0 6.7 7.8 6.1
Source: CSO (2009) and RBI (2009). RE=Revised Estimates, QE=Quick estimates

India has managed an economic growth of 6.1% during the first quarter of 2009-10 fiscal
year, even though the global financial crisis has affected manufacturing and certain services
like tourism. The GDP growth rate of 6.1 % during the first quarter of current fiscal year
2009-10 is higher than the 5.8% growth that was recorded during the last two quarters of
2008-09, even though it is much less than the 7.8% economic expansion recorded during the

15 

 
corresponding quarter of 2008-09 (RBI, 2009).7 Policy makers (the government and Reserve
Bank) have stressed that this positive growth indicates that the decline in growth rates has
been reversed.. The upturn reflected a recovery in industrial growth to 4.2% from less than
2% in the previous 6 months. Growth in the large services sector slowed to 7.7%, mainly
because of slower expansion in social and personal services; the other business-oriented
subsectors retained their momentum.

At the sub-sectors level, mining and electricity among industrial sector, and financing are
among the services sector which posted higher growth of 7.9, 6.2 and 8.1 %, respectively, in
the first quarter of 2009-10. Construction and community services also managed good growth
of 7.1 and 6.8 % in the first quarter of 2009-10 against 8.4 and 8.2 % observed in the
corresponding quarter of 2008-09, respectively. But agriculture and manufacturing expanded
at a slower rate of 2.4 and 3.4 %. Growth in services like hotels, trade, transport and
communication was significantly lower at 8.1% against 13% (Table 3). Let us look at the
industrial, consruction and toursim sectors somewhat in a detailed manner, before going into
demand side of the economy.

Industrial Production

The worst affected sectors have been those that are export-oriented and more labour
intensive. Since exports have been directly and immediately affected, and since
manufacturing exports were among the major growth forces in India, it is to be expected that
industrial production would be immediately hit. The trends in the index of industrial
production (IIP) show that the  
deceleration in the industrial Chart 10: Decelerating Trends in the growth (% YoY) of Industrial
Production has been reversed since April 2009
sector precedes the global 18
financial turmoil. IIP growth 16
has actually declined since the 14
beginning of 2007-08 (Dua 12
et.al. 2008, Rakshit, 2009). 10
The global financial crisis has 8
only worsened this slowdown. 6
Apart from the cyclical 4
downturn, while part of the 2
0
slowdown was policy induced
-2
as the Reserve Bank tried to
2005M10
2005M12

2006M10
2006M12

2007M10
2007M12

2008M10
2008M12
2005M4
2005M6
2005M8

2006M2
2006M4
2006M6
2006M8

2007M2
2007M4
2007M6
2007M8

2008M2
2008M4
2008M6
2008M8

2009M2
2009M4
2009M6
2009M8

cool down the overheated

economy, infrastructure
bottlenecks (e.g., shortages of
power forced companies to work limited time) also played major role for this slowdown. It
may be noted that the lack of key structural reforms constrained the expansion of
infrastructure and thus continuation of the high growth phase. There are two international
channels through which the industrial production has been hit hard. One is high commodity
prices which reduced profits margins and business confidence since 2007-08. Other is the
sharp fall in export growth in 2008-09, which is highly correlated with the global economic
conditions. To mitigate these adverse impacts, the government has unveiled both fiscal and

7
RBI (2009) Macroeconomic and Monetary Developments: First Quarter Review 2009-10 -Released on July 27, 2009
16 

 
monetary stimulus packages by cutting interest rates sharply, with tax exemptions and cash
transfers. These measures have reversed the declining trends in the industrial production
index by April 2009 (Chart 10).

The year-on-year increase in the index of Industrial Production (IIP) has been
decelerating since early 2007. Though growth of the industrial sector started to slow down in
the first half of 2007-08, the overall growth during that year remained as high as 8.5 per cent.
In 2008-09, the slowdown in growth of IIP is more clearly visible from the growth rates over
successive quarters of 2008-09, with with negative growth in the last quaretr of 2008-09. It
then staged an impressive rebound to over 8% in June 2009 and July 2009. According to
preliminary reports from CSO, India’s industrial output rose at its fastest pace (at 10.4%) in
22 months in August 2009, underpinned by strong expansion in mining and manufacturing.
Significantly, the upturn in the index was broad-based with basic, capital, and intermediate
goods registering impressive growth, indicating a general revival in activity.

RBI’s Industrial Outlook Survey conducted in April-May 2009 also suggests a

turnaround in the business sentiment. For the manufacturing companies in the private sector,
the businessexpectations indices based on an “assessment for April-June 2009” and on
“expectations for July-September 2009” improved sharply by 20.3 and 14.0 %, respectively,
over the previous quarter, when these indices had recorded their lowest level since inception
of the Survey (RBI, 2009). A preliminary analysis based on 3,126 companies shows that their
net profits climbed by 19.9% in the first quarter of 2009-10 from a 2.5% increase in the same
period of 2008-09, apparently mainly due to cost savings.

Construction Sector

The construction sector consists of different segments like housing, infrastructure,

industrial construction, commercial real estate, etc. The sharp rise in the GDP growth since
the beginning of current decade has been associated with a boom in the construction sector.
This is largely due to lowering of domestic interest rates following international interest rates
and also due to huge inflow of foreign
capital (both long term and short term)
Chart 11: Growth in the Construction Sector has been 
that created a sort of bubble in both the
decelerating since 2006
stock market and real estate sector. The
growth of construction output has seen 18
16
a sharp shift upwards from 2002-03 14
onwards and it reached its highest 12
growth of 16.5% in 2005-06. Further, 10
8
it has also shown a double-digit growth 6
for four consecutive years until 2006- 4
07. The construction sector has started 2
to slowdown since 2006-07 (Chart 11). 0
1991‐92
1992‐93
1993‐94
1994‐95
1995‐96
1996‐97
1997‐98
1998‐99
1999‐00
2000‐01
2001‐02
2002‐03
2003‐04
2004‐05
2005‐06
2006‐07
2007‐08
2008‐09

Apart from the cyclical downturn, the

slowdown was partly due to structural
factors and partly due to policy
induced. The sharp rise in the costs of
construction due to an increase in the prices of inputs like steel and cement had started
impacting the industry. Similarly, as there was an excessive price build-up in the form of a
speculative bubble, RBI cautioned the commercial banks in lending to construction sector
17 

 
which not only affected availability of credits to construction sector, but cost of credit
(interest rate) had also increased. The rise in interest rates and the slowdown in housing loans
caused slowing down of the construction sector. The fall in the liquidity in mid-September
2008 following the global financial sector turmoil precipitated a sharp downturn in the
construction industry in India.

This trend in the construction industry, particularly the declining trend since 2006-07,
indicates that the industrial/ economic slowdown in India has preceded the global financial
crisis. Although the Central Bank has reduced its policy interest rates, as part of their
stimulus programme in the third and fourth quarters of 2008-09, commercial banks’ response
to these cuts are quite slow and not complete. Hence, the benefits of monetary stimulus have
not been passed on to the credit takers. Further, as the global crisis has originated from sub-
prime lending in housing markets, the risk perception of banks about the construction
industry has gone up substantially, making the credit supply tighter for the construction in
India. These conditions might prolong the slowdown in the construction industry.

Tourism sector
Chart 12: India Toursim Sector affected due to gthe lobal financial crisis
India has one of the fastest-
growing tourism industries in the world. 6000
The share of tourism in India's GDP and Arrival Revenue
employment for 2008 is estimated at 6.36 5000
percent and 10.17 percent, respectively,
increasing from 5.83 percent of the GDP 4000
and 8.27 percent of total employment in
3000
2002-03. Nearly 3 million foreign tourists
arrived in India in the year 2003. But this 2000
figure has increased rapidly to 4.5 million
2006_1
2006_3
2006_5
2006_7
2006_9

2007_1
2007_3
2007_5
2007_7
2007_9

2008_1
2008_3
2008_5
2008_7
2008_9

2009_1
2009_3
2009_5
2009_7
2009_9
2006_11

2007_11

2008_11
in 2006, and to 5.1 million in 2007. The
foreign tourists spent $10.73 billion in
2007. About 5.36 million foreign tourists
visited India in 2008. The first five
months (Jan-May) of 2009 showed a sharp decline in the numbers of foreign tourist arrivals
in India as compared to the same period in 2008. But from June 2009 onwards, there has been
some improvement in the tourist arrivals. In the first nine months of 2009, 3.57 million
tourists arrived, drop from 3.87million in the first nine months of 2008. This shows that
foreign tourist arrivals declined by 7.7 % in the first nine months of 2009. However, the
foreign exchange earnings (FEE) have increased in the first nine months of 2009 to 3759
crores from 3646 crores in the first nine months of 2008. This shows that FEE has increased
by 3.1 % in the first nine months of 2009 (Chart 12).

Consumption demand, which had overtaken investment demand as the most important
contributor to demand growth in 2007-08, continued to be the dominant contributor to GDP
growth in 2008-09. With the sharp deceleration in the growth of private final consumption
expenditure in 2008-09, however, there was a compositional shift in the contribution to
growth from private consumption expenditure to government consumption expenditure (RBI
2009).

18 

 
 Private final consumption expenditure has maintained itself till the second quarter of
2008-09, but decreased to 5.3 % in the third quarter from an average of 7.2 % in the last two
quarters of the same year. Some of this was countered by a massive increase in government
final consumption expenditure. This increased to 24 % in the third quarter of 2008-09 from
the average of 7.5 % in the last two quarters of the year before. The spectacular growth rate in
the government final consumption expenditure was because of the implementation of the
sixth pay commission recommendation and farmer loan waiver subsidy during this period.
The gross fixed capital formation has decreased sharply in the third quarter of the year 2008-
09 to 5.3 % from 13 % in the previous quarter of the same year.

The contributions to growth by private consumption and investment as well as by

government spending fell heavily in the first quarter of 2009-10, while an unusually large
positive contribution came from net exports, primarily due to an import slump.

Table 4: India’s GDP growth projections by various agencies

Agency Forecasts for 2009-10 Month of Projection
ADB 6.0% September 2009
IMF* 5.4% July 2009
OECD 5.9% June 2009
NCAER 7.2% July 2009
EAC to PM 6 to 6.5% August 2009
RBI 6.0% with upward bias July 2009
CMIE 5.9% September 2009
World Bank 5.1% June 2009
India-LINK 5.8% September 2009
Planning Commission 6.3% September 2009
CITI Bank 5.8% August 2009
Source: RBI (2009) and others; * for calendar year

The results of eighth round of survey of professional forecasters’ conducted by the

Reserve Bank in June 2009 placed overall (median) growth rate for 2009-10 at 6.5 per cent.
There was a significant upward revision in the projection for India’s growth in 2009-10 by
professional forecasters in 2009 from 5.7 per cent to 6.5 per cent. For example, IMF growth
projection for India has been revised upward - from 4.5 per cent in April 2009 to 5.4 per cent
in July 2009 (RBI, 2009). This indicates that there is an upward revision in the latest round
and appears to show that the economic outlook in India turning out to be positive in the
recent period. This could be due to effective monetary and fiscal policy measures that are
taken in the recent period. The sectoral growth rate forecast for the agriculture sector was
revised downwards from 3 per cent to 2.5 per cent. The forecasts for industry were revised
upwards from 4.1 per cent to 4.8 per cent and for services from 7.5 per cent to 8.3 per cent in
the current survey. Median forecasts for different quarters of 2009-10 placed higher growth
for industry and services in the third and fourth quarters of 2009-10 (RBI, 2009). Taking into
account various factors including droughts and floods in different states, we estimate that
Indian GDP growth for 2009-10 will be around 6%.

The combination of countercyclical fiscal policies and renewed investor confidence is

expected to sustain growth in private consumption and investment in 2009-10. However, the
poor monsoon and drought in some states (as well as rcent flood in some other states) are
likely to affect adversely on rural incomes and consumption. To some extent this will be
offset by incresed government expenditure on rural development in the latest budget. Given
19 

 
countercyclical fiscal policy related expenditure, growth in 2009-10 is likely to be driven by
government expenditure, as in the case of last year but its impact in the current year will be
less than in the last year. This is because the private consumption contributed more to GDP
growth compared to the government in the in the last decade. This trend was reversed in
2008-09 as private consumption
slowed down due to high Chart 13: Unlike in the past, Government Consumption 
commodity prices in the first half Contributed more to Growth in 2008‐09, but the private 
and the global financial crisis consumption is likely to contribute more to growth in 2009‐10 (%)
linked with employment loss and 60
decline in wages in the second half
40
of the year. But at the same time
government consumption has 20
incraesed due to increased social 0
protection and fiscal stimulus in ‐20 2003‐04 2004‐05 2005‐06 2006‐07 2007‐08 2008‐09
2008-09. It is likely that this trend
‐40
will be reversed again as the
private consumption is picking up ‐60
Consumption (pvt.) Consumption (Govt)
quite dramatically in the recent 3 Gross fixed capital formation Net exports
or 4 months (Chart 13). Growth in
the second and third quarters is expected to fall below the first-quarter level of 6.1% because
of weak agriculture; However, it is likely that economy will recover sharply in the last
quarter.

From these forecasts we can confirm that the impact of global crisis on the Indian
economy appears to be short lived. Unlike in many countries in the world, Indian economy
has shown strong resilience with appropriate policy response. But, as the forecasts show, it
will take some more time to come back to its medium term growth of 8-9%. With a weak
and muted global recovery the Indian economy is unlikely to be able to revert easily to pre-
crisis levels of 9% growth, without long delayed fundamental structural reforms.

The wholesale price index (WPI) inflation declined during 2009-10 from 0.8 % at
end-March 2009 into turn negative (1.6% YoY) in June 2009, a rate that was sustained in
July and August 2009, largely reflecting the base effect of sharp increase in prices during the
first half of 2008-09. In Sep 2009, it increased at the rate of 0.4%. In the first six months of
current fiscal year 2009-10, WPI declined by
Chart 14: Inflation Rates based on the Wholesale and Consumer 
0.5 %. In the coming months, however, the
Price Indices moved in the opposite direction in 2009
upward presure on prices will likely exceed
the downward pull from the high base of a 14
12 GWPI    GCPI    
year earlier. Hence it is likely that year-on- 10
year inflation to be 4–5% by March 2010. A 8
worrying feature of the price structure is that 6
%

consumer price index (CPI) dominated by 4

2
food inflation not only remains high at 11% 0
in Sep 2009, but show an upward trend in the ‐2
last 3 or 4 months (Chart 14). In addition, a ‐4
2001M12

2002M12

2003M12

2004M12

2005M12

2006M12

2007M12

2008M12
2001M9

2002M3
2002M6
2002M9

2003M3
2003M6
2003M9

2004M3
2004M6
2004M9

2005M3
2005M6
2005M9

2006M3
2006M6
2006M9

2007M3
2007M6
2007M9

2008M3
2008M6
2008M9

2009M3
2009M6
2009M9

weak monsoon and droughts in some parts of

India and floods in some other oarts of India
are likely to reduce food production and so
will exert upward pressure on food prices in
20 

 
the coming months. The total stock of foodgrain with the Food Corporation of India (FCI)
and other Government agencies increased to about 51.8 million tonnes as on May 1, 2009
(RBI, 2009). The Government expects to cushion the weather impact by using this large
foodgrain stocks and by importing essential commodities.

The Impact of Fiscal Indicators

The fiscal consolidation that has started through FRBM Act (Fiscal Responsibility
and Budget Management) had brought some fiscal discipline in India. It had brought down
the fiscal deficit/GDP ratio of the Central Government from 6.2% in 2001-02 to 2.7 % in
2007-08. In the last budget the fiscal deficit was budgeted at 2.5 % in 2008-09. However, due
to the election year, with the implementation of both the Sixth Pay Commission award and
the farm loan waiver scheme, and fiscal stimulus packages, the actual fiscal deficit for 2008-
09 turned out to be around 6.1%.

Table 5: Receipts and expenditure of the Central Government

(As % of GDP)
2003- 2004-0 2005- 2006- 2007- 2008- 09 2008- 09
04 5 06 07 08 estimate actual
1. Revenue receipts (a+b) 9.6 9.7 9.7 10.5 11.5 11.3 10.6
(a) Tax revenue (net of 6.8 7.1 7.5 8.5 9.3 9.5 8.8
States’ share)
(b) Non-tax revenue 2.8 2.6 2.1 2.0 2.2 1.8 1.8
2. Revenue expenditure 13.1 12.2 12.2 12.5 12.6 12.4 15.1
of which:
(a) Interest payments 4.5 4.0 3.7 3.6 3.6 3.6 3.6
(b) Major subsidies 1.6 1.4 1.2 1.3 1.4 1.3 2.3
(c) Defence expenditure 1.6 1.4 1.3 1.3 1.1 1.1 1.4
3. Revenue deficit (2-1) 3.6 2.5 2.6 1.9 1.1 1.0 4.5
4. Capital receipts 7.5 6.1 4.4 3.6 3.6 2.8 6.4
5. Capital expenditure 4.0 3.6 1.9 1.7 2.5 1.7 1.8
6. Total expenditure 17.1 15.8 14.1 14.1 15.1 14.1 16.9
[2+5=6(a)+6(b)]
of which:
(a) Plan expenditure 4.4 4.2 3.9 4.1 4.3 4.6 5.3
(b) Non-plan expenditure 12.7 11.6 10.2 10.0 10.7 9.5 11.6
7. Fiscal deficit 4.5 4.0 4.1 3.5 2.7 2.5 6.1
Source: Union Budget documents.

Available data on monthly revenue receipts indicates that the revenues have indeed
experienced an absolute fall in the post-crisis period (since Sep 2008) compared to the pre-
crisis period. For example, in the first five months (April to August 2009) of current fiscal
year, the revenues have experienced an absolute decline of 4313 crores (3%) compared to the
corresponding period of 2008-09. Similarly during the last six months of fiscal year 2008-09
(Oct 2008-Mar 2009), the revenues have experienced an absolute decline of 44216 crores
(13%) compared to the corresponding period of 2007-08. This trend is reflected in both tax
and non-tax revenues. This is entirely due to the fall in overall economic activity as well as
tax rebate given as part of fiscal stimulus.

21 

 
 However, the public
expenditure in the post crisis Chart 15: Government's revenue has declined, while expenditure  has 
incresed in the last two years 
period has been well above the
140000
pre-crisis period. In the first
120000
five months (April to August Revenue
100000
2009) of current fiscal year, 80000
the expenditures have posted Expenditure
60000
an absolute increase of 63719 40000 Linear (Revenue)
crores (23%) compared to the 20000
corresponding period of 2008- 0 Linear (Expenditure)
09. Similarly during the last

2007M8

2008M2
2008M4
2008M6
2008M8

2009M2
2009M4
2009M6
2009M8
2007M10
2007M12

2008M10
2008M12
six months of 2008-09 (Oct
2008-Mar 2009), the
expenditures have experienced
an absolute increase of 160500 crores (36%) compared to the corresponding period of 2007-
08 (Chart 15). As discussed, the expansionary fiscal policy, adopted by India well before the
global crisis (e.g., farm loan waivers and the Sixth Pay Commission award) did result in
higher expenditures. Some argue that this ‘before the crisis’ fiscal expansion has minimized
the adverse impact of the global financial meltdown on India, but getting back to FRBM Act
targets will be a challenge.

The combined budgetary position of the Central and State Governments for 2009-10
indicates that the consolidated fiscal deficit as per cent of GDP is about 9.5%. Although the
combined revenue receipts are budgeted to grow, the combined tax-GDP ratio is budgeted to
marginally decrease in 2009-10 over 2008-09. On the expenditure side, while non-
developmental expenditure is budgeted to grow substantially and show a rise in terms of
GDP, development expenditure is budgeted to decline in absolute terms and consequently its
share in total expenditure and as a ratio to GDP would decrease in 2009-10 over 2008-
09(RBI, 2009).

The trends in revenue and expenditures appear to result in a fiscal deficit much higher
than the budgeted level. Some argues that the Central deficit could reach 7% as per cent of
GDP (without off-budget liabilities) and the consolidated fiscal deficit could reach as high as
10 % of GDP. But the degree to which these fiscal expansions could result in enhancing
aggregate demand is an issue. In the short run, it could create additional demand. But in the
medium term, this would largely depend on the relationship between private and public
investments. Before the crisis and economic slowdown, it was felt that public investment
was crowding-in private investments. But the sharp rise in public expenditure since the
beginning of 2008-09 seems to have potential to crowd-out private investments and, hence,
could delay the recovery in the industrial sector.

22 

 
4. Social Impact of the Crisis – Employment, Poverty and Human Development

The crisis in the real and financial sectors is having a social impact. Given the difficulty
of getting new and reliable data to assess the social impact of the crisis, we have followed
three different approaches: community-based or location specific rapid impact assessment
surveys focusing on vulnerable sectors/industries; a SAM (Social Accounting Matrix) model
consisting of 46 sectors; and an elasticity approach (e.g., poverty and employment elasticity
of growth) to project employment loses as well as the increase in the poverty levels.

Results from Quick Impact surveys

In this section we present the findings of quick-impact surveys done for selected
industries which are likely to have suffered heavily during the recent crisis. The surveys are
not based on any representative or stratified sampling but are intended to provide a quick
impression of how the crisis is affecting key industries and the workers in those industries.
By selecting industries which are likely to be most affected by the crisis these surveys will
exaggerate the impact of the crisis. But our intention through these surveys is not to gauge the
overall impact of the crisis but to see how well those most affected are coping with the crisis.

Impact on Diamond Cutting & Polishing Industry in Surat, Gujarat8

India is responsible for about four fifths of diamond cutting and polishing in the
world. Within India, about four fifths of diamond cutting and polishing is done in Gujarat.
Surat is the biggest diamond cutting and polishing centre in Gujarat, with about half the units
and 60 % of diamond workers of the industry working in the city. According to the RBI Task
Force, there were 2500 diamond units in the city, employing about 400,000 workers in city.
The crisis in the industry in Surat started with the fall in the demand for diamonds in the US
market. Subsequently the demand for diamond also declined in the EU and other markets,
which further aggravated the crisis. The crisis in the western economies reduced the demand
for Indian diamonds, as many traders preferred to use up the stocks and stopped buying fresh
stocks. The crisis started around October 2008 and the Diwali vacation in November 2008
became a turning point for the industry. Focus group discussions, field surveys of 127
workers and case studies together have provided good insights into the impact of the crisis on
Surat workers.

Impact on Employment, Wages and working conditions

• Of the total 127 workers surveyed, 57 workers (45 %) have lost their job during the
period Nov 2008 –Jan 2009 while 70 workers (55 %) have managed to get some work in
the industry at much lower wages. Of those who lost their job in the industry, 19 workers
managed to get some work in embroidery industry, casual unskilled work, petty business
and rickshaw driver, while 38 workers (about 30 %) remained unemployed.
• The average monthly income of the workers declined from Rs. 5896 before the crisis to
Rs. 3135 after the crisis – a decline of about 48 %.

8
This section is based on the report prepared by Indira Hirway for UNDP-India on Impact of the Financial
Crisis on Diamond Cutting & Polishing Industry in India
23 

 
• The average daily wage rate of the workers declined from Rs. 195 before the crisis to Rs.
102 after the crisis, again a decline of about 48 %.
• Before the crisis, most workers (more than 88 %) worked for 8 hours and more, with the
average working hours were 9.5 before the crisis. After the crisis, however, only 26 %
workers are able to work for 8 and more hours. The average working hours have declined
to 5 hours a day.
• Decline in wages due to reduced working hours seems to be a bigger problem than job
loss

Only one third of the workers received some support for protecting their consumption.
The government, the industry associations (SDA) and employers provided support in cash
and kind for food grains and other food items and for education expenditure. Very little help
was available for job search. The government’s support in training was not suitable and the
support from NGOs was almost non-existent. Only some employers provided help in getting
alternative work, mostly in the diamond industry. In short, about two thirds of workers were
left to fend for themselves in protecting their levels of living and four fifths of workers had
no support in searching alternative employment.

Dis-saving and Mortgage & Sale of Assets: Since diamond workers earn relatively good
wages, many of them had savings of their own. More than half the households used their
savings to survive in the crisis – at least in the initial months.

Increased Borrowing: Borrowing has also been an important coping strategy of some
workers. The number of households borrowing for consumption has more than doubled, from
26 (20 %) before the crisis to 65 (51 %) after the crisis.

Reduction in consumption expenditure is a major coping strategy - all except 14 households

(12 %) reduced their consumption in one way or other. The most important area of reduction
in expenditure was food. 112 households (88 %) reduced their food consumption. About half
the households stopped or reduced eating out.

It has been estimated that about half the worker of the total 400,000 workers who lost
their job have gone back to their native places- villages. A sample survey of 34 returned
workers to villages provided some insights into the impact of the crisis on returned workers.
A major problem with the returned diamond worker is that most of them are school drop outs.
Since they are used to making relatively good money, they do not want to take up unskilled
manual work at low wages. As a result, they do not fit well in the rural labour market. It is
not surprising therefore that almost one third of them are unemployed and waiting for better
days in a depressed state of mind.

To protect workers, the following areas need to be looked into:

• Universal Social Protection to Workers: There is an urgent need to design and
institutionalize a package of universal social security consisting of some minimum critical
social protection to all the workers in the economy.
• Ensuring Employment Services to Workers- There is a need to scale up- the employment
exchanges to set up employment services. The government can consider private –public
partnership in this area.

24 

 
• Ensuring Food, Health and Education for All The adverse impact of the crisis on the
workers / small producers could have been avoided if critical gaps in social goods –
health, education, skills were ensured.
• Special Packages for Women - though women provide “safety net” or become “shock
absorbers” by taking on them the burden of paid and unpaid work, there is a need to
address women’s problems in a focused manner and effectively.
• Extension of NREGA to urban areas: Extending NREGA to urban areas can provide
employment to the workers who have lost jobs in urban areas and this will also reduce
any significant reverse migration.

Impact on the Engineering Sector in Rajkot and Coimbatore9

Rajkot and Coimbatore represent large segments of engineering clusters specializing

in machine tools, agricultural machinery, and casting forging. The following analysis draws
on primary data collected from 120 workers and 30 micro enterprises operating in Rajkot
city, and 123 workers and 40 enterprises within engineering industry in Coimbatore.

Impact of the Crisis: the recent recession in the sector has adversely affected 82 % of
the workers in Rajkot. Only 21 out of 120 workers have escaped the adverse impact. In
Coimbatore, one third (i.e. 41) of the sample workers have been affected due to the economic
recession in the past one year. This proportion is fairly lower (almost half) as compared to
that found in the case of Rajkot.

Impact on Earnings and Wage Income -The survey in Rajkot suggests that as large as
92 % of the workers have experienced loss of income since October, 2008. In Coimbatore, 36
workers (i.e. 29.3 %) had experienced decline in total family income.

Consequences of Loss of Work - as large as 57 % of the respondents reported adverse

impact on the food intake-in terms of quality or quantity or both. Nearly 41 % reported
difficulty in seeking medical treatment; this included responses like shifting to cheaper
services, postponement of treatment or resorting to self-treatment etc.

Besides loss of work and income, several of the workers have resorted to various
forms of dis-saving and indebtedness. It was observed that as large as 53 % of the workers
had spent their past saving and 31 % had resorted to borrowing. The highest number of
responses are returning back to their places of origin (45 out of 138), followed by shifting to
a new activity/occupation (37), and by exploring work in other cities (28).

Findings from the Enterprise Survey in Rajkot

• Most of the units plan to continue in the same product line as shifting out may not be
feasible.
• The impact on workers appear to be mixed; several of the enterprises reported that
those who have gone to the respective villages outside the state may not come back

9
This section is based on the report prepared by Amita Shah, Dipak Nandani and Hasmukh Joshi
for UNDP-India on Impact of the Financial Crisis on the Engineering Sector in India
25 

 
 till the industry starts recovering; in any case they won’t be back before the end of the
sowing season.
• On the other hand a majority of the enterprises reported reduction in production/turn
over and sales as already noted.
• Remarkably, most of the respondents reported lack of adequate credit and help from
the Government ,

Findings from the Enterprise Survey in Coimbatore –

While it is difficult to gauge the intensity of the impact on engineering sector in

Coimbatore, it appears that the present recession has resulted in about 40-50 % reduction in
the total turnover; a substantial part is due to textile and auto parts related segments in the
sector. The impact is felt particularly on small and tiny enterprises and workers engaged in
them. Approximately 10 % of the small/ tiny units have already closed down and several of
them are functioning with only 50-70 % of the capacity.

To protect workers and enterprises, the following areas need to be look into:

• There is need to urgently address the issue of stability in prices and supply of raw
material and also ensure snags in power supply particularly in the case of Coimbatore.
• Flow of credit should be revamped especially to the small and tiny units to help overcome
the financial burden created due to fluctuating prices of raw material coupled with slow
down of demand and increased scalar competition within the industry.
• Another important aspect is providing basic infrastructure at affordable cost to small and
tiny units.
• Finally, a system of registration of enterprises and workers should be in place so as to be
able gauge the adverse impacts on the industry emanating due to various factors.

Impact of the financial crisis on Auto Parts Industry10

This analysis is based on a sample survey consisting of 125 households of the

workers, and 31 entrepreneurs in Ludhiana, Punjab. The survey reveals that all the 125
respondents were affected during October 2008 to March 2009. In 67 % cases, the workers
lost their job and are still unemployed, and in 48 % of the cases where the worker lost their
jobs but were subsequently employed, their retrenchment dues are yet to be paid. While
majority of them (55 %) have found the jobs in the same sector, most of them have accepted
the temporary status of casual labour or contract labour as against their previous regular
positions.

One of the likely impacts of such crises is on the education of the children. However,
the data suggests that in case of the majority of the households (56.8 %), there has not been
any change in the expenditure incurred on the education of the children. A significant finding
here is that in 85.6 % of households, there is no change in the status of the children or elderly
people at home.

10
This section is based on the report prepared by Santosh Kumar and Jignasu Yagnik for UNDP on Impact of
the Financial Crisis on the Auto Parts Industry in India
26 

 
 The issue of dis-savings has been one of the most painful concerns for the
householders to address. 55.0 % households are already liquidating the savings to compensate
for the declinein regular income. However, pawing of assets such as gold or silver jewellery
or land and other household assets, etc. has been reported only by 15.0 % respondents.

The affected workers and households have responded to declining income by

adopting expenditure-minimizing strategies such as changing dietary habits, cutting down
purchases of non-essential goods, and income-enhancing strategies including sending
children and women to work. For instance, as has been shown in other studies too (D'Souza,
2001), reduced incomes is often adjusted to by a modification of food consumption, by
diversifying food consumption, and compensating by consuming coarse cereals or in some
cases even wild foods.

Of the 31 firms surveyed, 84% have reported deterioration in their business, with the
biggest decline among the smaller ones. The medium or large units are comparatively better
because only 66.6 % reporting any deterioration. The smaller companies lost more than the
larger firms because they were not able to hold on to their products; instead they sold off the
products at a cheaper price or supplied their products to the larger companies, where delivery
was accepted promptly. For nearly 19 % of the industries, stock piling was not even possible
as they work on piece rate basis.

Availability of credit has been one of the concerns. As the data suggests for only 36 %
of the firms it was available easily from the Banks. Many firms are facing problems as the
suppliers of the raw materials have stopped supplying credit and on the other hand payments
to them for their production are delayed from the buyer. To cope with the situation, they have
been forced to reduce production.

Impact on employment and Poverty at the macro level – using growth elasticity
approach

After gaining a glimpse at the impact on the most vulnerable industries we now turn
to assessing the likely overall impact on employment and poverty. To judge the impact of the
financial crisis on employment generation this paper projected employment losses by using
the elasticity of employment with respect to changes in GDP growth. The underlying
assumption behind this approach is that employment elasticity based on historical data can be
used to measure future change in employment. In normal times, this is a fair assumption, as
the employment elasticity is likely to be stable. However, in a recessionary economy, due to a
number of cost cutting measures taken by the affected sectors, the employment elasticity may
not remain stable. In this context, the estimates coming from this approach need to be
interpreted carefully.

For this exercise, we assume two growth scenarios: For the first and baseline scenario,
we assume that India’s GDP will be about 8% both in 2009 and 2010 (pre-crisis scenario).
For the second scenario, we assume that India’s GDP will be about 5.4% in 2009 and 6.5% in
2010 mainly due to the global financial and economic crisis (post-crisis scenario). These
assumptions are in line with projections made by ADB, IMF and others for India during the
pre-and post-crisis period. Our attempt here is to assess how employment situation in India
might change under these two different growth scenarios. Using these GDP projections for
2009 and 2010 and combining them with the employment elasticity of 0.38, we estimated the
27 

 
employment impact of the crisis. It appears that because of the financial crisis, the
employment will fall by about 8 million in 2009 and 12 million in 2010 (see Table). These
estimates are in line with ILO figures on unemployment rate for 2008 and projected figures
on unemployment rate for 2009 (ILO 2009).

Table 6: Employment Projection for India

Employment in Millions
Scenario 1 (pre-crisis Scenario 2 (crisis scenario)
scenario) with the with the assumption of GDP
assumption of GDP growth growth of 5.4% in 2009 and Loss in Jobs
Year of 8% in 2009 and 2010 6.5 % 2010 in million
2006 465.0 465.0 n/a
2007 474.7 474.7 n/a
2008 489.1 488.0 1.1
2009 504.1 496.5 7.6
2010 519.6 507.2 12.4
Note: Annual rate of employment increase is 2.74 %, average GDP Growth during 1999 –
2007 is 7.12 %, and based on the above, the average employment elasticity growth is 0.384

These numbers only tell us about potential employment loss, but as we have seen in the
survey’s presented in the previous section, decline in wages due to reduced working hours
seems to be severe problem in the major exports-oriented manufacturing industries compared
to job losses or lack of new jobs. Consequently the number of the working poor, which is
already high in India, is likely to go up further in the crisis situations. These are people who
still have some employment but do not make enough and fall into poverty. Available data
show that there is significant increase in casual labour in India, which has reduced the
bargaining position of the employees considerably.

Similarly we have attempted to assess the impact of the financial crisis on poverty
reduction in India through the poverty elasticity approach. Using two different GDP growth
scenarios indicated above for 2009 and 2010 and combining them with the poverty
elasticity 11 of -0.59 for India, we estimated employment impacts of the crisis. The key
findings of the exercise are as follows:

• Poverty incidence (based on national poverty line) continued to decline, but rate of
poverty reduction is slowing down; and

• 5 million more people will remain in poverty in 2009 than was expected in 2008; by
2010, this figure goes up to more than 8 million.

Results from SAM modelling12

11
Annual rate of poverty reduction during 1993-2004 is -2.42; average per capita GDP growth during 1993-
2004 is 4.12; and poverty elasticity of growth with respect to changes in per capita GDP is -0.59.
12
This section is based on the report prepared by India Development Foundation (IDF) for UNDP and the
World Bank on “the impact of the current growth slowdown on employment, poverty and income distribution”
28 

 
 To assess the impact of the slowdown on different sectors of the economy, this paper
also presents the results of a Social Accounting Matrix (SAM) model for the year 2003-04,
consisting of 46 sectors developed by India Development Foundation in New Delhi. The
sector-wise exports generate demand for both final (direct requirement) and intermediate
(indirect requirement as inputs that go into these sectors) goods and services. These direct
and indirect requirements along with their total impact on the economy can be obtained from
the SAM. We have taken exports as the exogenous factor where any external shock given,
results in increase or decrease in the economy.

To estimate the impact of the slowdown on different sectors of the economy, the
study has taken two scenarios: Scenario 1 (optimistic) and Scenario 2 (pessimistic). Both
these scenarios are benchmarked against the rate of economic growth prior to the crisis. For
the base period, exports of goods and services grew at an average of 24.5 %, which is
consistent with the overall growth of 8.6 % during 2006-08. In the current year it has been
growing at 16 % in year 2009-10 which is consistent with the 5.6 % (6 %) growth in GDP
during the same year.

The five main sectors which are export oriented and contribute around 33 % (SAM
2003-04) in the total exports of goods and services are textiles, leather & leather products,
other manufacturing, other services and tourism. Since there is no separate gems and
jewellery sector available in SAM, we have taken other manufacturing sector as proxy for the
same. Gems and jewellery sector contributes 60 % of output in the ‘other manufacturing’
sector. Similarly software and business services sector contributes more than 50 % in the
‘other services sector’. The maximum reduction in growth is expected in the tourism sector
from 43.8 % in historical period to 28.6 % in 2009-10. Leather & leather products sector is
projected to grow at 12.8 % in 2009-10 compared to 19.6 % during 2006-08 (Table 7).

Table 7: Sector-wise Growth Scenarios (%)

Scenario 1
Years Historical(2006-08) 2009-10 2010-11 2011-12
Total overall growth 8.6 5.6 6.4 7.3
Textiles 15.0 9.8 11.1 12.7
Other Manufacturing 17.0 11.1 12.6 14.4
Other Services 11.6 7.6 8.6 9.8
Tourism 43.8 28.6 32.6 37.2
Leather & Leather products 19.6 12.8 14.6 16.7
Scenario 2
Total overall growth 8.6 4.1 5.0 5.8
Textiles 15.0 7.0 8.6 10.1
Other Manufacturing 17.0 8.0 9.8 11.5
Other Services 11.6 5.4 6.7 7.8
Tourism 43.8 20.6 25.2 29.6
Leather & Leather products 19.6 9.2 11.3 13.3
Source: IDF calculations

29 

 
Impact on employment

As we have seen earlier, the slower growth in the economic activity also translates
into job losses in the economy. Total employment in the economy prior to the slowdown was
around 481 million person years. With the slowdown of economy, this number is projected to
go down to 469 million person years in 2009-10. This suggests that total job loss in the
economy due to the financial and economic crisis is likely to be around 12 million person
years. The five sectors namely textiles, other manufacturing, leather & leather products, other
services and tourism are highly labour intensive in nature. If these five sectors alone are taken
into account, the total job losses would be 1.27 million person years. The maximum job
losses of 0.55 million person years is in the textile sector followed by ‘other services’ sector
with 0.38 million person years and 0.16 million person years for ‘other manufacturing’ sector
(Table 8).

Table 8:Sector-wise employment scenarios (million person years)

(Scenario 1)
Years Historical(2006-08) 2009-10 2010-11 2011-12
Total overall 481.0 468.7 471.9 475.7
Textiles 12.1 11.5 11.7 11.9
Other Manufacturing 3.2 3.0 3.0 3.1
Other Services 10.5 10.2 10.3 10.4
Tourism 1.2 1.1 1.1 1.1
Leather 1.0 0.9 1.0 1.0
Total of five sectors 28.0 26.7 27.0 27.4
(Scenario 2)
Total overall 481.0 462.1 465.9 469.5
Textiles 12.1 11.3 11.4 11.6
Other Manufacturing 3.2 2.9 3.0 3.0
Other Services 10.5 10.0 10.1 10.2
Tourism 1.2 1.0 1.0 1.1
Leather 1.0 0.9 0.9 0.9
Total of five sectors 28.0 26.0 26.4 26.8
Source: IDF calculations

Impact on the Household income

The slowdown in exports leads to decrease in output of the economy. Of late, the
increase in income has been the highest for the middle and upper middle classes. Therefore in
the period of slower growth the maximum loss will be for the same category of households.
The difference in the growth in income for these two classes from historical period to 2009-
10 is 4.1 % and 3.4 respectively (Table 9). Rural sector income for both the above mentioned
classes increases at a growth higher than the urban sector. However, within the rural sector
we find that the distribution of income has not been in favour of people in ‘abjectly poor’ and
in ‘poor’ category. Out of the total income generated in rural areas, only 2 % reaches the
‘abjectly poor’ and 7.5 % to the ‘poor’ population. Together, the low income groups in rural
areas have been getting less than 10 % of the total income generated in the rural sector.

30 

 
Table 9: Scenarios for the Income growth by Poor and Non-Poor Households

Years Historical(2006-08) 2009-10 2010-11 2011-12

Rural Sector (Scenario 1)
Abjectly poor 7.4 4.9 5.5 6.3
Poor 7.5 4.9 5.5 6.3
Middle class 11.9 7.8 8.8 10.1
Upper middle class 9.9 6.5 7.4 8.4
Rich 8.7 5.7 6.4 7.4
Urban Sector (Scenario 1)
Abjectly poor 7.3 4.8 5.4 6.2
Poor 7.3 4.8 5.4 6.2
Middle class 8.9 5.8 6.6 7.5
Upper middle class 8.0 5.3 6.0 6.8
Rich 7.7 5.0 5.7 6.5
Rural Sector (Scenario 2)
Abjectly poor 7.4 3.5 4.3 5.0
Poor 7.5 3.5 4.3 5.0
Middle class 11.9 5.6 6.8 8.0
Upper middle class 9.9 4.7 5.7 6.7
Rich 8.7 4.1 5.0 5.9
Urban Sector (Scenario 2)
Abjectly poor 7.3 3.4 4.2 5.0
Poor 7.3 3.4 4.2 5.0
Middle class 8.9 4.2 5.1 6.0
Upper middle class 8.0 3.8 4.6 5.4
Rich 7.7 3.6 4.4 5.2
Source: IDF calculations

Impact on the poverty

For the poverty calculations the study has assumed poverty in the rural sector to be
28.2 % and 25.6 % for the urban sector. The respective poverty line of INR 356 and INR 538
(Planning commission) for rural and urban sector has been updated till 2008-09 using
consumer price index to update the poverty line. Monthly per capita expenditure is assumed
to grow at the same rate as that of the poor category of household income. In Scenario 1 the
poverty declines by 2.4 % for the rural sector and 1.8 % for the urban sector in the historical
period. However, in the year 2009-10 poverty increases by 1.4 % and 1.3 % respectively for
the rural and urban sectors due to lower growth in the income of the households. Poverty
increases in the following years but at a slower rate as the growth in the economy starts
picking up and for the rural sector it again decreases in the year 2011-12, where as the urban
poverty keeps on increasing at a slower pace in the base period. On the other hand, in
Scenario 2 poverty increases by 2.4 % in the rural sector and 1.6 % for the urban sector.

31 

 
Table 10: Scenarios for Rural and Urban Poverty Incidences
(Scenario 1)
Years Historical(2006-08) 2009-10 2010-11 2011-12
Rural -2.39 1.39 0.76 -0.46
Urban -1.82 1.33 1.30 0.07
(Scenario 2)
Rural -2.39 2.42 1.83 0.47
Urban -1.82 1.67 1.60 0.08
Note: (-ve) sign denotes decrease in poverty and (+ve) sign denotes increase in poverty
Source: IDF calculations

Using three different approaches we have shown the social impact of the crisis. The
surveys and the SAM model show that the workers in sectors where the transmission effects
of the crisis are large will face a huge employment and poverty impact. There are very few
benefits to these workers, who are mostly casual labour, from the various social protection
programs that abound in India. In most cases these workers are getting less regular
employment and more intermittent and casual work. We have also seen that the overall
impact on poverty will be quite large and job losses will rise to around 12 million. In addition
with falling real wages the number of “working poor” will rise.

32 

 
5. Assessing the Response To The Crisis

In this section we assess the economic stimuli packages, the effectiveness of India’s
numerous social assistance programmes and progress on more medium-long term structural
measures.

Fiscal Responses

In assessing the impact of the fiscal stimulus, one needs to estimate its impact on GDP
through the fiscal multiplier. The IMF (May 2009) provided a survey of fiscal multipliers for
several countries based on past studies. The study indicated that the size of the fiscal
multiplier is country-, time-, and circumstance-specific. According to the study a rule of
thumb is a multiplier of 1.5 to 1 for spending multipliers in large countries, 1 to 0.5 for
medium sized countries, and 0.5 or less for small open countries. Smaller multipliers (about
half of the above values) are likely for revenue and transfers while slightly larger multipliers
might be expected from investment spending. The five crucial determinants of the fiscal
multiplier are as follows: the size of the fiscal stimulus, its composition, the magnitude of
automatic stabilisers, the amount of fiscal space and the extent of taxation of the financial
system and the housing and equity markets.

There is some difference of opinion on the estimated size of India’s fiscal stimulus for
2008-09. While the IMF puts it at 0.5 % of the GDP, the Indian representative at April’s G-20
placed it at 4 % of GDP and the Finance Minister in his budget speech gave a figure of 3.5 %
of GDP. If one looks at the composition of the fiscal stimulus one find that the pre-budget
stimuli mainly comprised (i) cuts in excise duty and service tax (ii) infrastructure spending
and (iii) bank capitalisation. The salient feature for a successful fiscal stimulus is three Ts
namely Targeted, Timely and Temporary. From this view, general tax cuts are an inferior
option. The tax cuts announced in India, for example, are largely expected to benefit higher
income households, who may not spend the entire additional income put in their hands by the
tax cuts. Similarly, infrastructure spending may not be very effective as a short-term stimulus
measure. Recognising that the earlier fiscal stimuli were not having the intended effect, the
Finance Minister in the last Budget correctly shifted the focus of the fiscal stimuli to areas
where the multiplier effects of expenditure would be high, such as the National Rural
Employment Guarantee Programme and other social protection schemes.

India is not in favourable position to use fiscal stimulus due to higher levels of fiscal
deficit and public debt. We should also note that India has “limited room” for additional
fiscal stimulus should the country’s economic condition deteriorate. Some economists are
suggesting that the fiscal stimulus should not be unwound soon, still others are suggesting
that fiscal policy has done enough and that monetary policy should take over now. By
assuming that the actual size of the fiscal stimulus package is only for 0.5 % of GDP (most of
which on the expenditure side), we estimate the fiscal multipliers on the Indian economy.
This shows that it will be about 0.5 % for 2009, and 0.3 % for each of the years, 2010 and
2011. However, if one concedes that the actual fiscal stimulus in India is in the range of 3.5
% of GDP (most of which on the tax rebate), the fiscal multiplier for 2009 would be about 2
%.

33 

 
Table 11: Fiscal Stimulus Packages in India
Date
Amount Proposed Initiatives announced
Increase in planned Support to exports, textile sector, infrastructure, housing 7-Dec-08
expenditure and tax and SMEs
cuts (INR 200 billion) Increase expenditure on public projects to create
plus employment and public assets
amount provided in the Petrol and diesel prices cut by Rs 5 and 3 per litre
budget for 2008 but respectively
mostly unspent (INR Interest rate cuts on loans for infrastructure and exports
2800 billion) Cut of 4% in excise duties across the board on all
(Total INR 3000 billion, manufactured goods (except petroleum products)
USD 60 billion)
Package to help realty India Infrastructure Finance Company Limited permitted to 2-Jan-09
and infrastructure sector raise funds to provide refinancing to public sector banks in
the infrastructure sector
External Commercial Borrowings policy liberalized to
increase lending to borrowers in the infrastructure sector
Countervailing duty and special countervailing duty re-
imposed on cement imports
Tax cuts Service tax cut across the board from 12% to 10% 25-Feb-09
Excise duty reduced by 2% for items currently attracting
10%
Source: ESCAP 2009, Economic Survey, GOI

As part of crisis management, India has already unveiled three fiscal stimulus
packages before the recent Union Budget, in which there were many other policies changes
that is expected to lead to fiscal expansion. Given high fiscal deficits and recovery of some
key sectors like industry, it is unlikely that government will come out with any additional
fiscal stimulus. If it is do so, then it should come in the form of a boost to public investment.
Such public investment should be used for human development and physical infrastructure of
direct benefit to the poor. The argument that higher public investment could ‘crowd out’
private investment depends on the size of the fiscal deficit and overall public debt. In many
developing countries major increases in public investment has gone hand in hand with
buoyant private investment. The best examples of this complementary relationship are seen in
China and Vietnam. If anything, the evidence points to a ‘crowding in’ through the familiar
multiplier effect and the impact of profit expectations and cost reductions associated with
improved infrastructure. Countries such as, Indonesia and Pakistan that have witnessed
declining share of public investment in the 1990s have experienced a slow growth of private
investment.

However, there are limits in special circumstances to the use of expansionary fiscal
policy, involving deficit financing of higher public investment outlays. If government suffers
under a large internal debt, then such a policy may lead to an unsustainable fiscal position.
Large fiscal deficits tend to pre-empt loanable funds, foster high real interest rates and crowd
out productive investment. As Acharya (2009) pointed out in India the fact that periods of
declining fiscal deficit have been associated with acceleration in economic growth (1992-97
and 2003-2008), while periods of rising deficits correlate with slowdowns (1997-2002)

34 

 
cannot be ignored. In this sense, one of the key macroeconomic challenges confronting India
over the next few years is bringing down fiscal deficits to modest level.

The full Union Budget for 2009-10 estimates the fiscal deficit for Centre alone in
2009-10 to be at 6.7% of GDP compared to 6.0% in 2008-09 and up from 2.7% in 2007-08. It
may touch 7% of GDP because of the poor monsoon and recent floods. But the composition
of 2009-10 is qualitatively different from that of 2008-09. In 2008-09, the rise in fiscal
deficit is largely due to farm loan waivers and the hike in the pay for the government
employees, although the first three stimulus packages, which concentrated more on the export
sector and some tax exemptions, also contributed. In 2009-10, total expenditure is planned to
increase by 16.1% (to 17.5% of GDP), including large increases for public investment in
infrastructure, the National Rural Employment Guarantee Scheme, and Bharat Nirman—a
programme for rural infrastructure. Spending priorities reflect the Government’s goal to
support the rural poor and to accelerate infrastructure development while continuing the fiscal
stimulus.

On a combined basis (central and state governments) India has been running large
fiscal deficits for over 30 years. Until recently, in any given year, India’s fiscal deficit would
typically figure among the top seven or eight countries in the world. Concerted efforts by the
central government brought the consolidated deficit down to a manageable 6.5 % of GDP by
the mid-1990s. This however was reversed in the next five years because of the large public
pay increases after 1996/7, low revenue buoyancy and weak expenditure control policies. By
2001/2 the consolidated fiscal deficit was nearly 10 % of GDP. A sustained effort at fiscal
control resumed after 2002/3 and brought the consolidated fiscal deficit down to 5 % of GDP
in 2007/8 (Acharya, 2009).

The uncertainty surrounding the macroeconomic developments world over in 2009-10

and the need for minimizing the second round impact of the global shock call for a continued
fiscal policy stimulus. While in 2008-09 fiscal expansion in an overall sense helped arrest the
decline in growth, given the relatively weaker automatic stabilizers in operation in the
country, a more selective discretionary fiscal policy was used to address the affected sectors
and sections of work force in a sustainable manner and promote investments that would not
only boost demand in the short run but yield long run growth dividends. Within the proposed
fiscal expansion, the mix of expenditure and tax cuts would be critical in the context of its
impact on overall macroeconomic fundamentals like growth, interest rates and exchange rate.
A commitment to return to the new FRBMA mandate, as it is envisaged in the Economic
Survey: 2008-09, as soon as possible is critical for markets to synchronize their expectations
with that of Government and work in a coordinated manner towards the restoration of a high
growth momentum.

A major concern is the sharp rise in the cost of debt servicing. The growth of interest
rate payments is expected to see a rise from 13% in 2008-09 to 17% in 2009-10. Another
major component is the increasing share of central government subsidies in the total non-plan
expenditure, which has increased substantially from 15% in 2007-08 to 21% in 2008-09. For
the year 2009-10, it is proposed that the overall subsides be brought down to 16%, which it is
still high and going to be difficult to contain. On the revenue side, the Budget appear to be
confident in rising the non-tax revenue by 45.8% compared to 2008-09, while it projects the
tax revenues close to the previous year’s level. The recent unveiling of new direct tax code is
expected to increase tax buoyancy and also broaden the tax base. Consequently, the revised
35 

 
budget projects revenue to grow by 12.8%. In terms of GDP, it is projected to reach 10.5%.
More reforms are under way: for example the Government plans to introduce a national
goods and services tax on 1 April 2010 (to replace the multiplicity of central and state
indirect taxes and rate structures) in efforts to move toward a unified national market and to
strengthen the revenue base. Recently the Ministry of Finance has proposed for public
discussion a significant reform of the direct tax system, which would markedly lower
corporate and personal tax rates while ending a complex web of special exemptions and
exclusions. The new system is expected to be in effect from 1 April 2011.

Monetary Responses

During financial year 2007-08 in the backdrop of increased capital inflows, changes
in the policy rates mainly involved the cash reserve ratio (CRR) (which was increased by 150
basis points from 6.0 % to 7.5 % from November 10, 2007); the repo rate (RR) of 7.75 % and
the reverse-repo rate (R-RR) of 6.0 % were left unchanged (Chart 16).

During the first six months Chart 16: RBI Policy Rates have been raised until Aug 

of the financial year 2008-09, RBI 2008; after the crisis set in Sep 2008, they have bene 
consciously endeavoured to control 10 reduced substantially
monetary expansion through
8
increases in CRR and RR. While
CRR was increased by 150 basis 6
points in six tranches from 7.50 4
(before April 26, 2008) to 9.0 % 2
from August 30, 2008, RR was also
29‐Apr‐05

14‐Apr‐07

26‐Apr‐08

21‐Apr‐09
8‐Dec‐08
2‐Oct‐04

4‐Aug‐07

25‐Jun‐08
31‐Mar‐04

25‐Jul‐06
23‐Dec‐06

19‐Jul‐08
30‐Aug‐08
20‐Oct‐08
3‐Nov‐08
24‐Jan‐06

31‐Jan‐07
3‐Mar‐07

17‐Jan‐09
24‐May‐08
increased by 125 basis points in
three tranches from the level of 7.75
(as it prevailed on April 1, 2008) to Cash Reserve Ratio Repo rate Reverse repo rate
9.0 % on. August 30, 2008. These
changes were made in the context
of monetary expansion and double-digit inflation in the economy. The R-RR was, however,
left unchanged at 6.0 % (Chart 16).

The subsequent six months of the financial year 2008-09 witnessed a tight liquidity
situation in the economy. In view of this, RBI facilitated monetary expansion through
decreases in the CRR, RR, R-RR and the statutory liquidity ratio (SLR). The CRR was
lowered by 400 basis points in four tranches from 9.0 (as of August 30, 2008) to 5.0 % w.e.f.
January 17, 2009. The RR was also reduced in the wake of emerging liquidity crunch, by 400
basis points in five tranches from 9.0 (as of September 30, 2008) to 5.0 % on. March 5, 2009.
The R-RR was lowered by 250 basis points in three tranches from 6.0 (as it was prevalent in
November 2008) to 3.5 % on. March 5, 2009. The reductions in R-RR were simultaneous
with decreases in the RR (Chart 16).

The SLR was also cut by 100 basis points from 25 % of net demand and time
liabilities (NDTL) to 24 % with effect from fortnight beginning November 8, 2008. In
addition, sector-specific steps to ease liquidity were introduced, in consonance with an
upward revision of the indicative target growth rates for broad money and bank credit to the
commercial sector.

36 

 
 In the last 12 months, RBI has adjusted the policy rates several times. Currently, the
repo rate is at 4.75%, the reverse repo at 3.25%, and the CRR at 5%. Consistent with RBI
current assessment of macroeconomic and monetary conditions, RBI has decided to keep all
these rates unchanged in its recent round of monetary policy on 28 July 2009. This is largely
due to the declared huge market borrowing programme of the Government during 2009-10,
compared to 2008-09, which is expected to crowd-out private investments through rise in the
overall interest rate structure.13 Further, this heavy government borrowing has also led to a
rise in inflationary expectations. Overall, the Reserve Bank’s intervention helped in
maintaining orderly conditions in the foreign exchange market and ensuring overall
comfortable liquidity in the system. RBI’s actions have resulted in augmentation of
actual/potential liquidity of over Rs.5, 61,700 crore. In order to ensure that the increased
Government market borrowing programme does not crowd out credit flow to the private
sector, the projection of money supply (M3) growth for 2009-10 has been raised to 18 per
cent from 17 per cent indicated in the Annual Policy Statement in March 2009 (RBI, 2009).

Interest rates and money supply

The threat of inflation resulted in hikes in domestic policy interest rates during 2004-
08. But the global financial crisis and subsequent policy responses across the world has
forced the RBI to reduce interest rates and reserve requirement limits sharply. There has
been a significant reduction in the key policy rates by the RBI in order to ease liquidity and
strengthen the credit delivery mechanism in the economy. This was also facilitated by
moderating inflation since September 2008 following marked decline in international food
and fuel prices. In view of a very different inflation scenario, the CRR has been reduced by a
cumulative 400 basis points from 9% to 5% since October 2008. The repo rate was also
reduced to 5% and reverse repo to a low of 3.5% (Chart 16).

Although the Central Bank has taken adequate monetary measures to ease tight the
liquidity situation, commercial
Chart 17: Despite dramatic reduction of RBI's Policy
banks lending rates remained Rates, Commercial banks's Benchmark Prime
stickier. The Benchmark Prime Lending Rate remained high
15
Lending Rate (BPLR) by the end
of March 2009 was still at a high
14
of 11.5-14% (Chart 17). With
Per Cent

rising inflation, but with the

need to finance such large fiscal 13
deficits through the RBI India
will most likely soon face major 12 Lower Band of BPLR
Upper Band of BPLR
policy dilemmas. If the fiscal
deficit is not brought down it
11
financing must either squeeze
credit to the private sector or
stoke inflation.

13
The combined net market borrowings of the Central and State Governments in 2008-09 were nearly two and
half times their net borrowings in 2007-08. These are budgeted to increase further by nearly 34 per cent in 2009-
10. Management of the large market borrowing programme in a non-disruptive manner requires active liquidity
management and, accordingly, the Reserve Bank indicated its intention to purchase government securities under
open market operations (OMO) during the first half of 2009-10 (RBI, 2009).
37 

 
 In India, money supply growth declined to 18.4% during 2008-09, which was lower than
21.2% in the previous year (Chart 18). Growth in key monetary aggregates during 2008-09
reflected the changing liquidity
Chart 18: Growth Rate of Money Supply decelerated  since 2007 Q1 
conditions in the economy due to in India
domestic and global financial
30
conditions. Net domestic credit to the
China India
commercial sector and net foreign
25
exchange assets with the banking
sector have declined. These are the two 20
main components that were previously
pushing the overall money supply 15
growth above the targeted level. Bank
credit to the commercial sector 10
declined from 21% in 2007-08 to
16.9% in 2008-09. However, the credit
to the centre increased significantly
from 8.6% to 41.7% over the same
period. This means that the liquidity available to the banks has been channelled to cover the
government deficit instead of commercial sector activity. Growth in foreign exchange assets
has also declined sharply from 42% to 1.4%, which is consistent with the decline in the
foreign exchange reserves.

Enhancing Social protection

An external shock of this nature will have different effects – and therefore require a
different response – from say safety net programmes put in place to tackle natural disasters
such as drought or floods. Fortunately there is useful experience from the Asian Financial
Crisis to draw on. The key lessons from that experience were:

ƒ Expand or modify established safety net programmes rather than creating new ones
ƒ Protect pro-poor spending (not only health and education, but infrastructure too)
ƒ Learn from previous experience: a work requirement improved targeting; food subsidies
can help the poor, but are often poorly targeted and therefore expensive; unconditional
cash transfers can be faster to roll out than more sophisticated conditional cash transfers.

Many existing safety net programmes in India use food as a mechanism to transfer
resources to the poor and vulnerable sections of society. However, several challenges
confront food-based programmes. The extent to which food-based programmes target
households in real need of food remains questionable. Recently, the Indian government has
introduced some form of social assistance to vulnerable people such as landless rural
labourers and poor older people. Some involve millions of people, as in NREGS, while
others reach much smaller populations. There is a large variety of schemes, from subsidies at
local/provincial levels to national schemes that provide a regular support to vulnerable
people.

Can India Afford Enhanced Social Protection?

38 

 
 India spends less as a share of GDP on social protection than many emerging
countries. In India the main social safety net is via product subsidies (e.g. on fuel and rice),
and is often fragmented among many schemes. A multiplicity of small schemes each reaches
only a small number of beneficiaries, providing meagre benefits and leaving gaps and unmet
needs. India can therefore make some headway by consolidating multiple schemes into a
more coherent programme. There is also significant scope for moving from product subsidies
to more targeted and equitable cash transfer schemes.

Major Recent Social Safety Net initiatives in India

Aam Admi Bima Yojana - Under a new scheme called “Aam Admi Bima Yojana” (AABY),
launched on October 2, 2007, insurance to the head of the family of rural landless households in the
country will be provided against natural death as well as accidental death and partial/permanent
disability. This cover is Rs. 75,000 on death due to accident and permanent disability due to
accident, Rs. 37,500 in case of partial permanent disability due to accident and Rs. 30,000 in case of
death of a member, prior to terminal date. The premium under the scheme is Rs. 200 per annum per
member, 50 % of which is contributed by the Central Government and remaining by State
Governments.

Rashtriya Swasthya Bima Yojana- The Rashtriya Swasthya Bima Yojana was formally launched
on October 1, 2007. All workers in the unorganized sector who come in the category of Below
Poverty Line (BPL) and their families will be covered under the Scheme. The scheme also has a
provision of smart card to be issued to the beneficiaries to enable cashless transaction for health care.
Total sum insured would be Rs. 30,000 per family per annum with Government of India contributing
75 % of the annual estimated premium amount of Rs. 750 subject to a maximum of Rs. 565 per
family per annum while State Governments are expected to contribute 25 % of the annual premium
as well as any additional premium. The cost of smart card would also be borne by Central
Government.

National Old Age Pension Scheme (NOAPS) - Under the Scheme, the Central Government
provides Rs. 200 per month of financial assistance per beneficiary. The eligibility criteria for
NOAPS has been recently modified from “who is 65 years or above and a destitute” to one “who is
65 years and above and belonging to a household below the poverty line”. The scheme is
administered by the Ministry of Rural Development.

Source: The Economic Survey, Govt of India, 2007-08

39 

 
 National Rural Employment Guarantee Scheme (NREGS)

National Rural Employment Guarantee Scheme (NREGS), which is a demand-driven scheme

carrying a legal guarantee for employment NREGS, was launched on February 2, 2006. It
represents a major expansion in India’s spending on public works. Under the scheme, every rural
household is guaranteed up to 100 days of unskilled manual wage employment per year, at the
statutory minimum wage for agricultural workers in the state. If employment is not provided
within 15 days, the applicant is entitled to unemployment allowance. The scheme aims to provide
work on labour-intensive projects focusing on rural infrastructure. A key feature is that the
scheme is to be implemented through local governments, unlike earlier schemes that were
implemented by the central or state governments. In the first phase, it covered 200 most
backward districts; in the second phase, it has been expanded to 330 districts. Now it rolled out to
all 596 rural districts in India with provision of Rs.160 billion (US$ 3.2 billion), which is about
0.4 % of GDP. The scheme, which is still in early stages, has received mixed reviews so far.
According to official reports, it has done well in meeting demand for employment: In 2007-08,
33.9 million households were provided employment and 1435 million person-days were
generated in 330 districts. The enhanced wage earnings have led to a strengthening of the
livelihood resource base of the rural poor in India. In 2007-2008, more than 68 % of funds
utilized were in the form of wages paid to the labourers. However, concerns about corruption
have been raised. Also, implementation has been found to be highly variable across (and even
within) states. Self targeting in nature, the programme had high works participation of
marginalized groups like SC/ST (57 %), women (43 %) in 2007-2008. In 2007-08, 1.79 million
works have been undertaken, of which 49 % were for water conservation, 15 % were for rural
connectivity and 12 % were for land development. The Central Government has been
encouraging the State Governments to make wage payment through bank and post office
accounts of wage seekers. Thus far, 42.2 million (up to September, 2008) NREGA bank and post
office accounts have been opened to disburse wages. The NREGA workers are also being
encouraged to obtain insurance under Jan Shri Bima Yojana.

In principle, the NREGS could make a significant contribution to reducing rural unemployment
and poverty. Research suggests that the lean season rural poverty rate could be reduced by 10–15
percentage points, with poorer households benefiting more than others. However, India’s
experience with public works programs raises questions about whether such a program is the
most effective way to address rural unemployment. As noted in Ajwad (2007), there have been
implementation problems such as misuse of program funds, ghost workers, and underpayment of
wages. In addition, the cost of the program—set to rise from 0.2 % of GDP in 2006/07, to as
much as 0.4 – 0.5 % of GDP once the scheme has been rolled out nationally in 2008/09. There
are also more fundamental concerns about the effectiveness of this spending. First, as with most
workfare programmes, it is unclear how large the economic return from the projects undertaken
(which are supposed to focus on roads and agricultural infrastructure) will be. Second,
implementing such a large programme entails significant administrative burdens, and demands a
level of efficiency and accountability that previous programmes have largely failed to achieve.
Close monitoring and evaluation will be critical to ensure the programme’s success.

40 

 
 Health Insurance to poor people in India

A healthy, educated and skilled workforce can contribute more significantly and effectively
to economic development. The National Rural Health Mission (NRHM) was set up in 2005
to strengthen effective healthcare delivery to rural populations throughout the country
especially states that have weak public health indicators and/or infrastructures. The NRHM
has placed special focus on the health of women and children and the reduction of maternal
and infant mortality rates. More than 23,000 Primary Health Centres (PHCs) across India
form the cornerstone of accessible and affordable rural healthcare. However their resources
are stretched thin making it difficult to provide quality healthcare. Private partnerships are
critical in increasing healthcare access to the masses. Countries such as China, Indonesia
and Thailand are experimenting with multiple approaches to expanding health coverage.
One model that seems to be working well is Thailand’s universal coverage “30 baht’
scheme, which has sharply increased health utilization rates among the poor while reducing
out of pocket spending. Another model is new public health insurance programme of
Tamil Nadu in India. In a pioneering initiative, the Tamil Nadu Government recently
launched 'Kalaignar Insurance Scheme for Life Saving treatment' benefitting 10 million
poor people who will now have access to private hospitals for quality treatment. The
scheme, providing an insurance cover up to Rs 100,000 for certain procedures in private
hospitals and pay wards in government hospitals to those families having an annual income
of less than Rs 72,000, was in July 2009.

41 

 
6. Achieving Inclusive Growth in India

It is widely believed that the Indian economy witnessed near stagnation in real GDP
growth from independence till the late 1970s. A closer review of the performance of the
Indian economy, however, suggests a somewhat different picture (Chart 19). Mohan (2008)
showed that real GDP growth
accelerated since Independence Chart 19: India's GDP Growth has been accelerating over the 
except during the period 1965-1980. last six decades
The slowdown of GDP growth 12
witnessed during 1965-80 was 10
reversed during the 1980s: the pick-
8
up benefited from the initiation of
6
some reform measures aimed at
increasing domestic 4

%
competitiveness. Since the early 2
1990s, growth impulses appeared to 0
have gathered further momentum
1951‐52
1954‐55
1957‐58
1960‐61
1963‐64
1966‐67
1969‐70
1972‐73
1975‐76
1978‐79
1981‐82
1984‐85
1987‐88
1990‐91
1993‐94
1996‐97
1999‐00
2002‐03
2005‐06
2008‐09
‐2
with more comprehensive reforms. ‐4
There was, however, some loss of ‐6
the growth momentum in the latter
half of the 1990s which coincided with the onset of the East Asian financial crisis, slowdown
in agriculture growth affected by lower than normal monsoon years, and some slackening in
the pace of structural reforms. Monetary tightening in the face of inflationary pressures is
also believed by some to have contributed to the slowdown in the late 1990s. A closer look at
the sectoral composition of growth shows that the slowdown was confined to agriculture and
industry; services continued to grow fast and even accelerated.

Since 2003-04, there has been a distinct strengthening of the growth momentum. The
proximate drivers of this growth spurt included the sustained investment boom, cumulative
productivity-enhancing effects of reforms, an unusually buoyant international economic
environment and a demand-and- technology driven acceleration of modern services output
(Acharya, 2009). Overall reduction in domestic interest rates facilitated by low inflation and
accommodative monetary policy and commitment rules-based fiscal policy have also led to
real GDP growth averaging about 8.7 % per annum over the 5-year period ended 2007-08
(Mohan, 2008). Agricultural growth remained variable, substantially dependent on weather
conditions. The sector has been unusually buoyant in the previous three years 2005-2008,
contributing significantly to the 9 % plus rate of overall economic growth.

The acceleration in the economic growth in India from “the Hindu growth rate” of
around 3.5 to 5.5 % in the early 1980s, then to 6.5 % in the late 1990s, further to 8-9 %
during the period 2002-2007 is evidence of the success of early economic reforms focusing
on the gradual liberalization of industry and trade policies in the 1980s as well as deeper and
broad based reforms on all sectors of the economy. On the demand side the growth
acceleration has been driven by investment and supported by private consumption. External
trade, in terms of the balance on goods and service trade, has played an insignificant role. A
notable feature of the recent GDP growth has been a sharply rising trend in gross domestic
investment and saving, with the former rising by 13.1 % of GDP and the latter by 11.3 % of
GDP over five years till 2006-07 (Economic Survey 2009).
42 

 
 Looking forward the question of whether domestic demand can compensate for the
negative exports growth remains to be answered. India has had strong domestic demand
historically, mainly due to high private consumption –GDP ratio (64 % in the late 1990s).
The contributions of government and private final consumption expenditure to growth
increased in the period between 1996-97 and 2001-02 but started falling sharply since 2001-
02 (Economy Survey, various years). Last year (in 2008-09), it reached to 59 % (Table 12).
Though this ratio is still high compared to China (48%), the declining consumption ratio
should be kept in mind when discussing the drivers of growth in a crisis situation. It is
investment that has risen sharply as a ratio of GDP. The sharp rise in investment has been the
driver of the high GDP growth rate in recent years. Given the economic crisis and low
business confidence, there will be a sharp decline in private investment as a ratio of GDP.
Government through fiscal stimulus and high fiscal deficits is expected to expand its
investment to compensate partly for this fall in private investment. But there will be some
decline in the overall investment ratio, which is bound to have a sharp impact on GDP
growth.

Table 12: Demand side growth in GDP, growth contribution and relative share (figures in per cent at 1999-00 market
prices
   2003-04 2004-05 2005-06 2006-07 2007-08 2008-09
GDP at market t prices 8.4 8.3 9.3 9.7 9.1 6.1
Consumption (pvt.) 5.9 5.2 7.1 6.3 8.5 2.9
Consumption (Govt) 2.6 3.6 6.2 5.5 7.4 20.2
Gross capital formation 17.6 21.8 19.5 13.2 14.7 Na
Gross fixed capital formation 13.6 18.9 17.6 14.5 12.9 8.2
Change in stocks -8.0 140.1 61.9 5.4 51.7 2.9
Exports 9.6 27.2 17.6 21.1 2.1 12.8
Imports 13.8 22.2 41.1 24.5 6.9 17.9
 Contribution to growth (per cent)                
Consumption (pvt.) 45.1 38.8 46.3 38.7 53.8 27.0
Consumption (Govt) 3.6 4.8 7.1 5.8 8.0 32.5
Gross fixed capital formation 38.4 56.4 51.3 43.9 43.6 42.5
Net exports -6.3 10.1 -41.1 -13.2 -14.0 -29.5
Source: Economic Survey, 2009

A look at the composition of GDP growth from the production side is also instructive.
The acceleration in the economic growth in India is mainly come from a rapid growth in
services sector. In the first half of 1990 services contributed just about half of total growth in
GDP. In the second half of the 1990s the sector’s contribution rose sharply to 68 % and has
remained at a high 64 % in the last seven years (see Table 13). The share would be even
higher if the construction sub-sector were included under services instead of industry.
Perhaps equally noteworthy but more disquieting is the low and declining contribution of
agriculture to GDP growth (Acharya, 2009). This structural shift in the composition is largely
due to the skewed policy reforms that has discouraged or bypassed agricultural sector and
went in favour of services. But this structural shift has not been seen in the level of
employment as the majority of labour forces continue to be engaged in the agricultural sector,
thereby reducing labour productivity. Hence, the benefits of reforms have been distributed
unequally and have resulted in large economic inequality in India. Several studies have
43 

 
shown that Gini coefficient has increased in the post reform period. Further, the reforms
have also resulted in regional divergences, resulting in forced migration.

Table 13: Sectoral Composition of Growth

Share in real GDP (%) Contribution to GDP Growth (% )
Average Average of 1991/92 to 1996/97 to 2001/02 to
of 1994-97 2004-07 1996/97 2001/02 2007/08
Agriculture 28.2 19.4 21.1 11.5 7.0
Industry 26.4 26.5 29.0 20.2 29.3
Services 45.4 54.1 49.8 68.3 63.6
GDP(Factor Cost) 100.0 100.0 100.0 100.0 100.0
Source: Acharya, 2009

The high saving and investment, combined with respectable rates of technological
progress has been a main driver of the India’s capital intensive non-agricultural led growth.
This growth pattern has not served India well in many respects. There are macroeconomic
downsides to this growth pattern. The first macroeconomic downside is that it may not be
possible to finance the current capital intensive mode of growth in the long run. Over time,
more of growth has come from capital accumulation, and less from employment and TFP
growth. A further macroeconomic downside is that this pattern of growth has created fewer
jobs than a more labour intensive pattern. The current growth pattern has contributed to
growing inequality. Accumulation of capital in industry and services has led to starkly
widening productivity differences, which in turn have led to large rural and urban income
inequalities. This is because India’s reliance on services and to some extent manufacturing
meant that urban formal sector jobs became rapidly more productive, and wages rose in line.
As a result, agricultural incomes increasingly lagged average income per capita, contributing
to inequality. During the last decade, inequality as measured by Gini coefficient has increased
dramatically, and on current trends India’s Gini could rise to Latin American levels. India’s
growth imbalances—investment and manufacturing & services driven growth in urban areas,
environmental strains, and income inequality—are likely to become worse. In this sense,
continuing with the current pattern will become increasingly difficult, economically,
environmentally, and socially.

Hence, the 11th Five Year Plan has shifted its focus from ‘high growth’ to ‘inclusive
growth’. The Plan has reinvigorated its focus on rural infrastructure. It also focuses on
achieving financial inclusion through providing credit at affordable price to needy sectors
such as MSME (Micro, Small and Medium Enterprises)14 and the farm sector. But whether

14
In India, the MSME sector plays a pivotal role. It is estimated that in terms of value, the sector
accounts for about 39% of the manufacturing output and around 33% of the total export of the
country. Further, in recent years the MSME sector has consistently registered higher growth rate
compared to the overall industrial sector. The major advantage of the sector is its employment
potential at low capital cost. As per available statistics, this sector employs an estimated 31 million
persons spread over 12.8 million enterprises and the labour intensity in the MSME sector is estimated
to be almost 4 times higher than the large enterprises. In this context, this MSME sector has been
accepted as the engine of economic growth and for promoting equitable development.

44 

 
India will be able to overcome the implementation challenges and translate these plans into
reality remains an open question.

Table 14: Poverty and Inequality across Rural and Urban Areas
Poverty Ratio (in %) Gini Index of Per Urban-Rural
Capita Consumption Disparity in Average
Expenditure (in %) Monthly Per Capita

Year Expenditure
Rural Urban Rural Urban
1973-74 56.4 49.0 28.7 31.9 1.334
1977-78 53.1 45.2 29.5 33.7 1.396
1983-84 45.7 40.8 30.0 34.1 1.458
1987-88 39.1 38.2 29.4 34.5 1.585
1993-94 37.3 32.4 28.5 34.4 1.628
2004-05 28.3 25.7 30.5 37.6 1.882
Note: Estimate of HCR and Average Monthly Per Capita Expenditure for 2004-05 are based on
Uniform Recall Period (URP) and for Per Capita Expenditure figures at current prices have been used.
Source:

Although the rural poverty has declined continuously, income inequality increased
from 1973-74 to 1983-84, declined from 1983-84 to 1993-94 and increased afterwards from
1993-94 to 2004-05. On the other hand, although urban poverty has been declining
continuously, urban inequality has been rising in an uninterrupted manner. Poverty reduction
in urban areas has been slightly faster than that in rural areas.

The question of course that we might ask is whether India can do better. It managed to
achieve roughly the same rate of poverty reduction during the period 1983-84 to 1993-94
with lower growth but declining inequality compared to the period 1993-94 to 2004-05 when
growth was much higher but inequality increased. For the future then the focus should not be
just on achieving very high growth but how to make growth more inclusive. High growth has
helped reduce poverty – on this there can be no doubt but India could have achieved much
faster poverty reduction had growth been more inclusive (Lipton, 2001). In order to judge
whether growth process had actually been pro-poor, it is important to look more deeply into
the sources of growth.

Trends in development expenditures

In an effort to contain the

fiscal deficit in the early 1990s, Development expenditure (as % of total expenditure)
there was a concerted effort to
reduce government expenditures 65
60
through reducing development
55
expenditures (which includes 50
economic and social 45
expenditures) in India. 40
Development expenditure as a 35
30
1980-81

1982-83

1984-85

1986-87

1988-89

1990-91

1992-93

1994-95

1996-97

1998-99

2000-01

2002-03

2004-05

2006-07

2008-09

45 

 
percentage of total expenditure has indeed gone down from 56% in early 1990s to currently
at 46%.

During the 1990’s, the government spending on agriculture and rural development as
% of GDP has declined in India. For example, the spending on agriculture and allied
activities as % of GDP has
declined from 1.15 % in 1990-91 Chart 21: Declining Trends in India's Public Expenditure (of the Centre 
and States) on Agiculture and Rural Development has been reversed  
to 0.7% in 2002-03; the spending
on irrigation has declined from 1.2
0.84 % in 1990-91 to 0.59% in 1.0 Fertiliser subsidy
2004-05; the spending on fertilizer

% of GDP
0.8
has declined from 0.77 % in 1990-
Irrigation
91 to 0.31% in 2003-04; and the 0.6
spending on rural development has 0.4 Agriculture & allied 
declined from 0.90 % in 1990-91 services
0.2
to 0.70% in 2000-01 (chart 21).
Rural development

1999‐2000
1990‐91

2000‐01
2001‐02
2002‐03
2003‐04
2004‐05
2005‐06
2006‐07
2007‐08
2008‐09
When the BJP government at the
Centre and Chandrababu Naidu’s
government in Andhra Pradesh lost
elections despite rapid growth and
India ‘shining’ advertisement, policy makers realised the importance of rural development.
Subsequently India’s fiscal policy has been adjusted somewhat to becoming more pro-poor
(Charts 21 and 22). The share of government spending on agriculture as % of GDP has
increased over the last 4 or 5 years. The current level is almost similar to the level recorded in
the early 1990s. Consequently, agricultural growth also accelerated from 2.0% during 2000-
04 to 4% during 2005-08. India also launched NREGS to support the landless in rural areas.
Numerous studies have been undertaken to find out what kind of public expenditure caters
most to the needs of the rural poor. It appears that the greatest impact on agricultural
productivity and poverty comes from investment in roads, irrigation, village electrification,
and from outlays on agricultural research and development and extension.

The recent data show that the investment (gross capital formation) in agriculture
sector, as a share of total investments, has declined from 8.6% in 1999-2000 to 5.8% in 2006-
07. However, the gross capital formation in agriculture as a ratio to GDP from agriculture is
increasing from 10.6% in 1999-2000 to 12.5% in 2006-07. The Economic Survey 2008-09
points out that to achieve 11th Plan target of 4% growth in agriculture, the capital formation to
agricultural GDP ratio needs to be increased to 16%.

Human capital is often seen as a constraint on economic growth and poverty reduction
in India. Average literacy rates in India are low. The literacy rate is 63% for males and 36%
for females. These rates are lower than those in many east and south-east Asian countries
even 40 years ago, and are no higher than modern day rates in sub-Saharan Africa.
Investments in human capital may represent a key means of increasing economic growth in
India. The total social sector spending in India accounts for about only 6.1% of GDP.

46 

 
 India’s spending on education accounts for about only 3.0 % of GDP. This ratio has
increased in the 1990s and then
declined in the early 2000s, but now Chart 22: India's  Public Expenditure (of the Centre and States) on 
once again it is increasing. India’s Social and Community Services has  increased in the last 5 years 

spending on health, water and 4

sanitation accounts for about only
3
1.2 % of GDP which has also Education

% of GDP
declined in the 2000s and now it is
2
increasing. However, expenditures Health and water 
supply & sanitation
on urban development as well as 1
social security and welfare as % of Urban 
development
GDP have steadily been increased 0
Social security & 
in the last two decades; the

1999‐2000
1990‐91

2000‐01
2001‐02
2002‐03
2003‐04
2004‐05
2005‐06
2006‐07
2007‐08
2008‐09
welfare
spending on urban development
from 0.14 % in 1990-91 to 0.54% in
2008-09, while spending on social
security and welfare from 0.25 % in 1990-91 to 0.64% in 2008-09. The total spending on
social and community services has also declined in the early 2000s, but it has rose from 5.1
% in 2003-04 to 6.5% in 2008-09 (Chart 22).

The expansion of social welfare and development projects in the recent decades
unaccompanied by a corresponding rise in budget resource allocation led to a thin spread of
resources across a large number of programmes. Access to public health care and education
services, by the poor especially got affected. The increased policy focus on the social sector
in recent times is yet to be reflected strikingly in a key indicator: the country’s social sector
expenditure as a percentage of its GDP. For instance, the Economic Survey (2007-08) shows
that the combined expenditure by the Central and State governments increased from
Rs.1,41,740 crore in 2002-03 to Rs.2,94,412 crore in 2007-08 (budget estimates), but as a
percentage of the GDP, this was a rise of just one half of one percentage point — from 5.77
% to 6.27 %. The official statistics are even more telling at a disaggregated level. Expenditure
on education, one of the key areas of social sector spending, fell from 2.90 % of the GDP in
2002-03 to 2.84 % in 2007-08, although in absolute terms it climbed from Rs.71,298 crore to
Rs. 1,33,284 crore. And, as a proportion of social sector expenditure, it fell from 50.3 % to
45.3 % (The Hindu News paper editorial, 19 June 2009). The persistent low level of human
development is one of the paradoxes of India’s development experience. A substantial boost
for the social sector in the next decade will ensure that the government will carry forward the
inclusive growth agenda effectively.

In the latest budget, the government may have enhanced allocation for its social sector
in the current budget but the net expenditure as percentage of the GDP is still too low in
comparison to some of the developed economies. The total combined expenditure of central
and state governments on social services in 2008-09 was 6.72% of GDP at current prices.
This is low when compared to what some of the Asian countries spend on their people. The
other services on the priority list in case of India include expenditure on safe drinking water,
sanitation services, housing, urban development, welfare of SCs, STs and OBCs, labour and
labour welfare, and relief on account of natural calamities. The share of money spent on
social services, including rural development, in the total expenditure (plan and non-plan) has
increased from 11% in 2002-03 to 19% in 2008-09. Central support for social programmes
has also continued to expand in various forms although most social sector subjects fall within
47 

 
the purview of the states. For instance, expenditure on education as a proportion of total
expenditure has increased from 9.5% in 2003-04 to 10.8% in 2008-09. Share of health in the
total expenditure has also increased from 4% in 2003-04 to 5% in 2008-09. But how well will
these expenditures translate into better social outcomes remains to be seen.

The high deficit is itself a threat to India’s growth and poverty reduction strategy. As
stated earlier, India has already unveiled three fiscal stimulus packages before the recent
Union Budget. With these fiscal measures, the fiscal deficit (to GDP ratio) is estimated to
increase sharply to 6.8% in 2009-10 compared to 6.2% estimated for 2008-09 (which is much
higher than the Budgeted deficit of 2.5% in Union Budget: 2008-09). Although currently
India may need such a large fiscal deficit , there are concerns about runaway fiscal deficits as
was seen prior to 1991 crisis in India, have the potential to destabilize the macroeconomic
situation and result in a high inflation rate and crowd-out private investment15. This view is
also supported by Subramanian (2009) 16 that India needs to kick-start its fiscal prudence
measures as India is comparatively in a better position to manage the crisis and recovery is
expected to be faster compared to most other countries.

There are also similar views from the government that the fiscal deficit needs to come
back to its erstwhile FRBM target of 3% by the end of 2010-11. It also perceives that the
high fiscal deficits are a constraint to rapid growth in the medium to long term while
recognising that in the short term it is necessary to stimulate additional demand17. Some have
argued that expansionary fiscal policy is necessary because monetary policy may not be an
effective stimulant due to persistent uncertainty and low business confidence. This may not
be untrue as the sharp reductions in the policy interest rates (by 400 basis points) in India
after the collapse of Lehman Brothers’ has not seen much impact on either credit off-take or
on the aggregate demand. Hence, even in India, monetary policy was less effective and that
led to fiscal profligacy18. But this debate between the effectiveness of monetary vs. fiscal
policy remains open. It is well recognised that monetary policy helped avoid bigger
recession. Moreover, historically it is found that during crisis only automatic fiscal policies
rather than discretionary fiscal policies, similar to the one that has been followed by many
countries in the current crisis scenario matter (Romer and Romer, 1994).Therefore, fiscal
stimulus may contribute to recovery but there are limits to it. And over the medium term
India must contain the size of its fiscal deficit and get back to the targets under its FRBM. .

If inflation were to accelerate and India was unable to control the rise of food prices
through sectoral measures then India will face a challenge. Monetary policy will have to be
tightened to try and dampen inflationary pressures. But higher interest rates would affect
private consumption and private investment reducing growth. While India’s fiscal stance can

15
Shankar Acharya (2009) says “Indian economy is likely to pay a significant price in terms of foregone
growth, inclusive development and, perhaps, rekindled inflation because of continuing high deficits. The
“calculated risk” of the present fiscal stance looks unduly high”. (http://www.business-
standard.com/india/storypage.php?autono=363371)
16
Arvind Subramanian (2009) “Fiscal Prudence: Now and here”, June 24, 2009, Business Standard.
(http://www.business-standard.com/india/news/arvind-subramanian-fiscal-prudence-nowhere/361905/)
17
See Economic Survey:2008-09 and also Arvind Virmani’s press brief on 3rd July 2009 in Indian Express.
(http://www.indianexpress.com/news/tightening-of-monetary-policy-seems-implausible/484368/0)
18
Surjit Bhalla (2009) “Can RBI forecasts be trusted?”, 1st August 2009, Business Standard.
(http://www.business-standard.com/india/storypage.php?autono=365542)
48 

 
be adjusted over the medium term towards targets set under the FRBM, monetary policy will
need to be more nimble to avoid stagflation.

Inclusive Finance Policy

There has also been a shift in the composition of banking sector credit against the
agriculture sector. The share of agriculture credit to total credit declined from 22% in 1990-
01 to 16.2% in 2000-01. Although it has seen a rise since then, currently the share is still at
20.5% in 2007-08. This is largely due to
shift in the focus of scheduled Population-wise distribution of gross bank credit (% of total)
commercial banks from rural to urban
sectors. We see a sustained rise in the 7060
share of credit to service sector from 50 Rural
8.6% in 1990-91 to 13.2% in 2007-08. 40 Semi-urban

Increasing competition in the banking 30 Urban

20 Metro
sector and rise in the NPAs in 10
agriculture credit appears to have 0
contributed to this shift. But the public
1971
1973
1975
1977
1979
1981
1983
1985
1987
1989
1991
1993
1995
1997
1999
2001
2003
2005
policy interventions through priority
sector lending and other policies appears to have had minimal impact on ensuring more credit
to agriculture.

By transforming their production and employment activities, access to finance can

enable people to exit poverty. In order to support this, the (RBI imposed a license rule in
1977 which stated that for each branch opened in a banked location (typically urban),
commercial banks had to open four branches in unbanked location (typically rural). This rule
was removed in 1990 and branch building in rural areas came to a halt. This seems to be one
of the reasons for this drop in credit/investment in the agriculture sector. The number of bank
branches in the rural areas has declined from 57% in 1990-91 to 41% in 2007-08. This has
also resulted in rise in urban and metropolitan regions from 24% to 37% in the same period
(see graph below). This shows that the banking operations appear to have shifted from rural
to urban regions.

This trend is the same when we look at the extent of gross bank credit provided to
rural vs. urban areas. The share of credit to
Sectoral credit by scheduled commercial banks (% of total)
metropolitan region has seen a sharp rise
since 1991-92, which has increased from 80
46% to nearly 63%. In the rural areas, the 70
credit share has declined sharply from 16% 60
in 1991-92 to 9% in 2007-08 (see graph 50 agri Industry Services
above). These trends in banking sector 40
only reinforce the view that to have a pro- 30
poor growth, there is a need for achieving 20
10
full financial inclusion. Some of these 0
shifts are of course inevitable as economic
1981
1983
1985
1987
1989
1991
1993
1995
1997
1999
2001
2003
2005
2007

activity shifts to urban areas but a vast

swath of rural areas are being left behind in
access to credit and other services and turning increasingly Maoist.

49 

 
 Recently, there were some measures taken in the Eleventh Plan to improve the market
access to agriculture sector by improving rural infrastructure through the Bharat Nirman
programme.. Efforts were also made for the agriculture sector to respond to market price
changes. Commodity exchanges, which are playing a major role in the international markets
in helping both farmers and the consumers, have been introduced in India. But they are still
in a nascent stage and policy interventions are hindering their development. Moreover, the
ban on commodity futures trading in the wake of rising global prices and also on exports of
agricultural commodities acted as a disincentive and curtailed the development of the
commodity markets.

Debate on pro-poor growth

Ravallion and Datt (2002 and 1996) using 23 surveys over the 1958-1991 period and
private consumption per capita data from the national accounts reveal an elasticity of poverty
reduction due to growth of –1.2. Cross-country studies on the relationship between growth
and poverty reduction provide additional evidence on the impact of growth on poverty
(Ravallion, 2001). It has been estimated that, on average, a one percentage point increase in
the rate of per capita income growth can produce up to a -2 % decline in poverty provided
income inequality does increase. Countries of East Asia have managed an exceptionally high
average growth rate of per capita income of 6.4 %, in the 1990s, while the corresponding
growth rate for the group of South Asian countries is 3.2 %. The incidence of poverty has
declined sharply in the former sub-region by 6.8 % annually, whereas the rate of decline in
South Asia has been relatively modest at about 2.4 %. For the Asia-Pacific region as a whole,
a one percentage point increase in the growth rate of per capita income has translated into
only about 0.7 to 0.9 % decline in the incidence of poverty in the 1990s.

However, some countries in certain periods experienced pro-poor growth. This

includes: China’s remarkable success in poverty reduction during the initial years after the
systemic land reforms in 1979 was largely because of a sharp improvement in agriculture’s
terms of trade and an increase in public expenditure for the rural economy. Similarly, when
India experienced relatively fast agricultural growth (mainly due to the green revolution) in
the 1970s and in the first half of the 1980s, poverty declined despite a relatively low rate of
economic growth. However, the slowdown in agricultural growth in the 1990s, despite high
economic growth, has had an adverse impact on the pace of poverty reduction. Further, the
astonishing egalitarian and poverty alleviating growth in Indonesia during the 1970s and the
1980s was principally due to a diversion of a high proportion of public investment towards
the rural areas, and to reforms of the domestic trade and marketing regime, which led to an
improvement of the agricultural terms of trade. Similarly, despite growth in per capita income
of about 3 %, Malaysia and Sri-Lanka in the 1980’s were able to reduce poverty annually by
as much as four to 7 % due to falling inequality. Migration provides another path out of
poverty even if growth is slow and inequality is rising. A striking example of success in
poverty reduction, despite slow growth (under 2%) and rising inequality is that of Pakistan
during the decade of the 1970’s due to inflow of remittances from workers in the Middle
East. Kerala too offers a similar success story in poverty reduction in the 1980s. These
examples reveal that if economic activity is to be favourable to the poor, then it should have a
pattern that directs resources to the sectors in which the poor work (agriculture), areas in
which they live (relatively backward regions), and factors of production which they possess
(unskilled labour)..

50 

 
 In India, it seems quite ironic that in the 1970s when the growth rate of GDP was
around 3 to 4 %, the growth rate in employment was hovering around 2 to 3 %. Consequently
the growth elasticity of poverty was relatively high. But, in the 1990s, when the growth rate
of GDP has picked up substantially, the employment growth rate is just about 1 %. The
growth elasticity of employment and poverty declined sharply. The paradox could be largely
explained by near stagnation in the growth of agriculture. The growth of employment in
agriculture in the 1990s was nearly zero. However, the latest quinquennial NSS survey,
namely, the 61st round, reveals a faster increase in employment during 1999-00 to 2004-05 as
compared to 1993-94 to 1999-2000. But it is still lower than in the 1970s.

7. Findings and Conclusions

The analysis in the paper suggests that India has been affected by the present crisis but is
managing to restore growth and recover. The most direct impact on the more vulnerable
sections of the population will come from sharp deceleration in annual growth (about 3
percentage point decline) from 9% to 6 %. India is less exposed to global developments than
others but is not totally immune, since exports contribute about one fourth of Indian GDP and
half of the exports are directly or indirectly linked with performance of developed economies.
Therefore, it is not surprising that demand contraction in the developed markets affected
Indian exports and the economy. Surprisingly the flow of remittances which was expected to
slow down because of the contraction of GDP in most of the countries which receive
maximum inflow of workers from India has remained resilient but if the global economy
remains weak it could be affected in the future

The most immediate impact of financial crisis has been on the short-term capital
flows. Financial deleveraging and a growing home bias have led to outflow of portfolio
capital from Asian developing countries. This has led to currency depreciation and running
down of foreign exchange reserves in some Asian countries. FDI flows have also come down
and but they are expected to decline more in 2009. But the most crucial impact in the
financial sector of Asia-Pacific countries has been the drying up of credit availability.
Decreasing risk appetite, higher spreads and poor business confidence have been responsible
for this. Though in a period of lack of aggregate demand, excess capacities tend to emerge
and consequently there is likely to be lack of demand for funds for new projects. But existing
firms may still need working capital to stay afloat. Funds may also be required for
depreciation and to finish ongoing projects which were undertaken before the crisis hit the
world economy. Lack of availability of credit will put a constraint on the industrial sector of
the Asia-pacific countries. But there are signs that these flows are reversing and equity and
currency markets have reversed sharply in recent months as confidence recovers and capital
seeks returns and risk is reduced. How buoyant this recent recovery remains will depend a lot
on global market developments.

This paper indicates that as the economy has slowed down there is going to be an
increase in unemployment rate in India. In addition there will be a drop in real wages and a
shift in the labour market towards more casual or contractual work. As a result there will be a
huge increase in the number of ‘vulnerable workers’ and the number of ‘working poor’ in
India. The effect of economic recession coupled with increasing casualization of work force,
declining collective bargaining position of workers are the major reasons behind such an
increase in labour market vulnerabilities. The quick impact surveys for key sectors, diamond
cutting, machine tools, and auto parts showed that workers in these sectors have been
51 

 
adversely affected and the existing social safety nets have not been of great help to them.
Families have coped by reducing consumption, dipping into savings, moving back to rural
areas, pulling children out of school and reducing their expenses on health care. All of the
predictable effects of a crisis have been borne out by the surveys. The myriad of social
assistance programs has not helped these people. A hard look at the various social assistance
programmes and how they could be adjusted to help the affected population would be a major
improvement in helping people deal with future crisis. NREGA provides some support but it
is not helpful to urban based workers who may have migrated from rural areas but are no
longer used to the hard work on rural schemes. Conditional Cash Transfer schemes could be
introduced to help such workers, who can be given temporary relief to help keep their
children in schools and supplement their income. Such schemes could be used to top up the
family earnings to bring them back above poverty along the lines of Singapore’s work fare
programs. These are different from the typical welfare schemes in Europe which discourage
work.

With the onset of crisis, more fundamental deep seated vulnerabilities of the Indian
Economy have started showing up more vividly. The exports sector has seen a sharp
reduction, which in turn resulted in decline in the growth of industrial sector. With the
presence of strong inter-sectoral linkage between industry and service sector, overall GDP
growth has seen a fall to less than 6% for recent two quarters. The fall in GDP growth in
India in the recent period is largely due to fall in the aggregated demand. With the absence of
external demand, escalating the domestic demand has been identified as the only way to
mitigate the impact of this crisis.

A large part of the slowdown can be explained by the tight monetary policy in the first
half of 2008 as well as decline in world demand that affected adversely Indian exports.
Looking forward the question of whether domestic demand can compensate for the negative
exports growth remains to be answered. India has had strong domestic demand historically,
mainly due to high consumption –GDP ratio (above 60%). But in recent years there has been
a sharp decline in the ratio of consumption to GDP in India and in 2008-09 it reached 57 %.
Though this ratio is still high compared to China (48%), the declining consumption ratio
should be kept in mind when discussing the drivers of growth in a crisis situation. It is
investment that has risen sharply as a ratio of GDP. The sharp rise in investment has been the
driver of the high GDP growth rate in recent years. Given the economic crisis and low
business confidence, there will be a sharp decline in private investment as a ratio of GDP.
Government through fiscal stimulus and high fiscal deficits is expected to expand its
investment to compensate partly for this fall in private investment. But there will be some
decline in the overall investment ratio, which is bound to have a sharp impact on GDP
growth.

To decouple from these external shocks in the future, India needs to undertake further
reforms. One sector that was bypassed in the whole reforms process is the agriculture sector,
which has the potential to create domestic demand. Labour reforms are also needed to
improve the employment elasticity and reduce the incentives to casualisation of the labour
force. Although both industrial and service sector have been targeted and, hence, benefited in
the reforms process, agricultural sector is still reeling under various (both demand and
supply) constraints. Through innovative reforms, linking of this sector with rest of the sectors
in the economy can contain volatility in the growth and also mitigate external shock impacts.
Unveiling of commodity exchanges and government intervention in building rural
52 

 
infrastructure and linking rural and urban markets might help in decoupling. Acceleration of
infrastructure projects through faster land acquisition ( along the lines of the recent proposal
of getting project developers to acquire 70% of land with government ready to come in for
the remaining 30% and adequate compensation) , better monitoring and penalties for project
delays is a vital necessity for India .

Recent programmes such as National Rural Employment Guarantee Act (NREGA)

and Bharat Nirman programs are intended to focus on reviving the rural economy. But,
implementation remains weak. NREGA has become an important automatic stabiliser during
the crisis period as some of the workers who lost jobs in the informal sector started shifting to
NREGA as a source of employment. But in the process there appears to be a reverse
migration of informal sector from urban to rural areas. This calls for an urgent need for
NREGA-type automatic stabiliser in the urban areas as well.

The rate of GDP growth in India had spurted in the five years before the crisis to 8-9
%, making it the second-fastest growing economy in the world, after China. But at the same
time, the outcome of this growth has not necessarily been pro-poor. If anything, income and
asset distribution have worsened during the last decade. Nevertheless the acceleration of
economic growth represents an important achievement. Given that one-third of the world’s
poor live in India, any significant progress in poverty reduction in India will make a big
reduction in the world poverty.

In this context India cannot relax efforts to provide more opportunities for its poor.
The key question before us therefore remains how to achieve a rapid poverty reduction
through inclusive growth. There are lessons from the recent experience in India and
elsewhere that can guide policies and actions to accelerate growth and poverty reduction in
India. Just restoring very rapid but unequal growth will not solve India’s problems.

Given India’s high fiscal deficit spending more is not the answer. In fact India will
need to put in place a plan to reduce fiscal deficits over the coming five years and manage its
monetary policy more nimbly in the short term to avoid stagflation if inflationary pressures
build up quickly. Therefore reforms that will help raise more resources, improve the
effectiveness of existing resources, and improve the employment intensity of growth must be
the key focus of policy making in the coming year. We list five areas of emphasis:

First, India needs to accelerate its infrastructure implementation. This will require an
overhaul of the land acquisition system, monitoring and penalisation for delays in project
implementation.

Second, India needs to streamline its labour laws to improve the employment impact
of growth and to avoid the growing casualisation of the majority of workers with small elite
who have access to regular work. Employment guarantee schemes such as NREGS are
helping the very poor in rural areas but suffer from poor implementation. Combining these
with (modified CCT) workfare schemes for urban areas where workers are paid a supplement
to top up low wages in return for sending children to schools are also needed.

Third, India needs to accelerate financial sector reforms to improve access to finance,
for small and medium enterprises, lower costs of intermediation and widen the capital market

53 

 
are vital for sustained growth. The non-bank financial sector provides a huge reservoir of low
cost untapped capital for India’s investment needs.

Fourth, the increased outlays on social sector spending are welcome and even more is
needed but with such large deficits already haunting India perhaps a much greater focus on
outcomes – with a district by district monitored plan to improve education, literacy and health
outcomes is needed. State-level Human development reports which are now regularly
produced can be used to ensure that the outcomes are both monitored and improving.

Finally, India needs to reverse the long neglect of the rural areas has started to be
reversed but its impact is still unclear. Policies for promoting faster growth in agriculture and
rural areas may focus on the following:

• Higher priority in public sector allocations to rural development, especially in building

rural infrastructure.
• Effective and equitable management of water resources in ways that avoid the de facto
privatisation of ground and surface water supplies.
• Diversification of agriculture into labour –intensive high-value agricultural commodities
such as horticulture and livestock for increased profit incentives and employment
opportunities. This may require intervention by the state initially in the process of
marketing and in providing minimum support prices to help farmers manage the risks of
moving into new economic activities.
• Creating financial inclusion such that farmers and other rural producers have access to
affordable banking and insurance services.
• Strengthening of the backward and forward linkages between the agricultural sector and
the off-farm sector in the rural areas in order to create a virtuous cycle of growth of
incomes and employment.
• Development of small and medium–scale rural enterprises for agricultural processing and
provision of agricultural inputs will require greater outreach for extension of rural credit,
both farm and off-farm, by financial institutions.

As India resets for more inclusive growth it must also take on the issue of a more
sustainable growth and not follow a carbon intensive path followed by the developed
countries, while increasing energy access. That issue is not addressed here and will further
raise the challenges India faces. But just keeping our focus on recovery we can conclude that
India has done well in managing the crisis so far but must take on more fundamental reforms
to restore sustained inclusive growth. It has achieved much but has many more promises to
keep on improve the lives of millions of poor people. India is recovering well from the crisis
but Bharat needs much greater help both in the short and medium-term.

54 

 
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