Overview of the Indian Economy: Budget 2008 and beyond

By A.V. Vedpuriswar

The Indian Economy at a glance

The Indian Economy

1990 1999 2000 2001 2002 2003 2004 2005 2006 2007

-91

-00

-01

-02

-03

-04

-05

-06

-07

-08

GDP at factor cost Manufacturing Foodgrain (Mt) WPI FDI ($mn) FII ($mn) Forex reserves ($bn) IPOs (Jan-Dec)

5.6

6.1

4.4

5.8

8.5

7.5

9.4

9.6

8.7

9 176 12.1 97 0

7.1 210 3.3 2093 2135

5.3 197 7.2 3272 2590

2.9 213 3.6 4734 1952

6 175 3.4 3217 944

7.4 213 5.5 2388 11356

9.2 198 5.1 3713 9287

9.1 209 4.1 3034 12494

12.5 217 5.9 8479 7062

9.8 219 4.1

2.2

40

51

72

108

136

145

272

525

1981

1940

12402

9918

24779

33912

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The Rupee vs Dollar

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EIU forecasts
Key indicators Real GDP growth (%) Consumer price inflation (av; %) Budget balance (% of GDP) Current-account balance (% of GDP) Lending rate (av; %) Exchange rate Rs:US$ (av) Exchange rate Rs:100 (av) 2007 2008 2009 2010 2011 2012 8.7 6.4 7.8 5.8 7.2 5.5 7.4 5.2 7.7 5 8 5.2

-3.2 -3.1 -2.9 -2.8 -2.7 -2.5

-1.2 -2.4 -1.5 -1.5 -2.1 -2.7

13.1 12.8 12 11 10 10

41.3 38.5 36.4 35.5 35.1 37.8 37.9

35 34.5

38 38.1 37.6

Highlights of Economic Survey

Economy will slow down to 8.7% in 2007-08 Inflation projected at 4.4 per cent in 2007-08. Holding 9% growth will be a challenge. Inflation and infrastructure are the biggest growth challenges.

Skill dearth is causing attrition, wage hike; pushing inflation

Agricultural growth in FY'08 is seen at 2.6%, against 3.8% a year ago. Industrial growth slower at 9% in first 9 months of FY'08.

Recommendations in survey
Complete the process of selling 5-10% equity in previously identified profit making non-navratna PSUs. Phase out control on sugar, fertilisers, drugs. Sell old oil fields to private sector. Allow a share for foreign equity in retailing. Raise foreign equity in insurance to 49 per cent.

Allow 100 per cent FDI in greenfield private agri banks.

Key challenges

Challenges
Although BPO, IT, Telecom, manufacturing have boomed in recent years, Indias economy remains mostly agricultural.

Many parts of the economy are cut off from free trade.
Restrictions on FDI make growing businesses difficult. Economic reforms, especially labor market reforms, have been slow in coming. Even without significant reform, Indias economy has performed so well (growing by 9.4% in the fiscal year ending in March 2007) that it may be overheating. Huge supply side challenges remain. Especially when we consider that by 2025 the country could have more than 580m middle class consumers - Source : The Economist

Three main barriers to growth

Multiplicity of regulations governing product markets Distortions in the market for land. Widespread government ownership.

Unfairness and ambiguity Uneven enforcement Reservation for SSIs FDI restrictions Licensing

Unclear ownership Counter productive taxation Inflexible zoning, rent and tenancy laws

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Growth inhibitors

According to McKinsey (2001) these factors inhibit GDP growth to the extent of 4% plus every year.

Using resources effectively

Clearly this is the need of the hour

But what does the data tell us?

A quick look at Union Budget 2008

2008 Budget at a glance (Rs Crores)

2006-07 (Actuals) Revenue receipts Capital receipts Total receipts Non plan exp 434,387 149,000 583,387 413,527 2007-08 (RE) 525,098 187,275 709,373 501,849 2008-09 (BE) 602,935 147,949 750,888 507,498

Plan exp
Total exp Revenue deficit Fiscal deficit Primary deficit
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169,860
583,387 80,222 142,573 -7,699

207,524
709,373 63,488 143,653 -28,318

243,386
750,884 55,184 133,287 -57,520
15

Major plan expenditure

2007-08 (Rs. Crores) 2008-09 (Rs. Crores)

Rural development

17,511

18,972

Agriculture

8,544

10,075

Health & family welfare

12,049

14,878

Education

23,073

29,054

Urban development

4,808

5,674
16

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Where the rupee comes from?

Non tax revenue 10% Service & other taxes 7% Non debt capital receipts 2% Borrowings & other liabilities 14%

Excise 15%

Corporation tax 24%

Customs 13%

Income tax 15%

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Where the rupee goes?

Non plan assistance to state govt 5% States share of taxes/duties 19% State plan assistance 7% Central plan 19%

Other non plan expenditure 10%

Interest 21% Subsidies 8% Defence 11%

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Changing revenue mix

(Rs. billion) 2004 - 05 Corp tax Income Tax Customs 830 509 563 2008 - 09 2264 1383 1189 (% of total revenue) 2004 - 05 22 13 15 2008 - 09 29 18 15

Excise
Service Tax

1007
142

1379
644

26
4

18
8

Other
Tax revenue Non tax rev Total revenue

9
3060 751 3811

18
6877 958 7835
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0
80 20 100

0
88 12 100
19

Budget deficit
Currently, the revenue deficit is 1% of GDP.

Fiscal deficit is 2.5% of GDP.

But does this tell the complete story?

Off Balance Sheet items

Amount (Rs Crore) Debt Waiver Oil bonds Fertiliser subsidy Food subsidy Sixth pay commission Total Fiscal deficit budgeted Gross fiscal deficit
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% of GDP 1.12 0.21 0.14 0.19 0.47 2.13 2.50 4.63

21

60,000 11,257 7,500 10,000 25,000 113,757 133,287 247,044

 What

about the budget deficits of states?

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India vs China

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China is sitting pretty

According to official estimates, China's government ran a budget deficit of around 1% last year. But some economists reckon that the cautious government is understating its true fiscal health: it probably had a small surplus.

If the profits of state-owned firms were also added in, the government could have a surplus of around 3% of GDP. China's public debt has also fallen to only 17% of GDP, well below the average ratio of 77% in OECD economies.
Indeed, China has the best fiscal position of any big country, giving the government plenty of room to cushion the economy if demand suddenly falls. By contrast, India, though improving, has one of the worst fiscal positions in the world.

The Indian government claims it has reduced its deficit to an estimated 3.3% of GDP in the year ending March, from 6.5% in 2001-02. However, in a recent report the IMF argued that the true total deficit is closer to 7% of GDP once we add in the state governments' deficits and various off-budget items. If the losses of state electricity companies are also added in, the total deficit could cross 8% of GDP. India's public debt is also uncomfortably high at about 75% of GDP.

(The Economist)

Newspaper editorial
Should the Fiscal Responsibility and Budget Management (FRBM) Act be scrapped? For this law seems to be having the perverse effect of making the government hide more and more of its expenditure and not show it in the Budget. The finance minister can then claim that he is meeting FRBM targets, when in truth he is not. Scrapping the law might encourage more honest budgeting. Business Standard

Sectoral Reforms

Agriculture

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Farm loan waiver

Moral hazard? What about people who have borrowed from money lenders? Is this the best way to help farmers? To give a boost to agriculture? A scorched earth policy?

Options to minimise the damage

Give borrowers with good records lower interest rates.
Lower credit limits/impose higher collateral on bad borrowers. Reduce the risks in agriculture This will lower the number of intermediaries and bring down the consumer price. And improve the realisation for farmers.. Institutional reforms moneylenders. (Subhir Gokarn) to reduce the dependence on

Get back to the fundamentals

Increase output per acre. Reduce the gap between the farmers price realisation and what the consumer pays. Reduce wastage because of poor roads, inadequate warehousing and refrigerated transport.
Reduce the number of people dependent on agriculture. Encourage organised retailing, contract farming, ebusiness (A.V. Rajwade)

Industry

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No big ticket reforms in key industries

Power

Retail

Financial sector

Financial sector reforms

Reduce micro management by RBI and SEBI. Liberalise derivatives and commodity markets. Encourage more competition and innovation To be a global financial services player, India needs : - An open capital account - Capable and efficient markets - World class institutions and responsive regulators - Less intervention by RBI and MOF. - (Percy Mistry, MIFC report)

Raghuram Rajan Committee report

India is dangerously complacent. Its concerns about over-sophisticated
markets resemble a clock that looks right only because it is 12 hours behind. Indian households put only about half of their savings in the bank, and banks funnel less than half of their credit to private firms, . The government's financing needs crowd out other borrowers, and state-owned banks account for about 70% of India's financial assets . The cost of these financial failings is probably a percentage point or two of growth. They leave India's savers with too little reward for their thrift, its poorer borrowers with too few alternatives to the moneylender and its incumbent firms with too much protection from upstarts, who cannot raise money to compete. The Economist, April 12, 2008

If America's subprime crisis demonstrates the pitfalls of untrammelled

finance, India illustrates the opposite danger. Since its regulators get blamed only for mishaps, not for lost growth and wasted opportunities, they are too conservative. ... New ideas are banned unless explicitly permitted. This helps regulators feel more secure, but it does little for the system's stability. .For example, companies are barred from speculating in derivatives, but many have done so anyway. Those that have lost money now cite the very rules they broke as reason to back out of their obligations, saying they should not pay for mistakes they were not officially allowed to make. The Economist, April 12, 2008

Last year the government banned futures trading in two types of

bean, rice and wheat, arguing that speculators were driving up prices,... Some in the leftist parties, now argue it should extend the ban to other commodities, such as edible oils and perhaps even iron and steel. This would be like shooting the messenger, argues B.C. Khatua, chairman of the Forward Markets Commission, which regulates futures exchanges. Before they were shut down, . the futures markets conveyed the message that prices of wheat and rice would continue to rise. Sure enough, that is what happened. The Economist, April 12, 2008

The futures market provides farmers with a sneak preview of the

prices they will face in the months ahead, which should allow them to make an informed decision about what to sow. In principle, futures contracts should also allow farmers to lock in a price for their crops, insulating them from the vagaries of the spot market. At the moment, farmers are too small to participate in the market directly small banks could aggregate the demands of farmers up to a practical size. The Economist, April 12, 2008

Pensions
The existing formal pension channels dont cover unorganised sector workers. Given the dismal levels of penetration of financial services, a majority of Indian people are not contributing towards their oldage security.

The Pension Bill could bridge that gap, and give people greater control over their retirement benefits.

Pensions ( Cont..)
But the Left has been a stumbling block

In 1981, Ronald Reagan launched the 401K plan in the US. The US pension industry, which was $60 billion then, is today a $9 trillion industry, with most of the money invested in equities.

Under the shadow of the Left, the government has not moved on increasing FDI limits from 26% to 49% in insurance .

General economic reforms

Subsidies
Labour Education Entrepreneurship Legal system

Not a great place for entrepreneurs

It takes 71 days to get all requisite clearances for starting an enterprise in India.

The same will require just five days in the US, six days in Singapore and 48 days in China.

Legal system fails to deliver

It takes 425 days to enforce a contract in India, compared to 69 days in Singapore and 241 days in China.

According to a World Bank 2007 survey, Ease of Doing Business, India is ranked 177th out of 178 countries in enforcing business contracts.

Rigid Labour markets

The absence of a bankruptcy law and labour reforms, especially the difficulty in retrenching workers, has also reduced the competitiveness of Indian firms. The Industrial Disputes Act, 1947particularly, Chapter 5B bars manufacturing companies that employ more than 100 workers from firing employees without state government approval. Employers have been reluctant to add extra staff during peak seasons because they cannot be laid off during lulls. Despite having surplus labour in the country, many large employers are expanding output through capital investment wherever possible. (Amit Mitra, Secretary General FICCI)

Education
Higher education is a dark spot. Though FM has enhanced allocation for education, he hasnt done much for higher education. Starting a few IITs is not going to make much difference to the country. Bold steps are called for to open the sector. While steps have been announced to invest in skills development and education, clearly they are timid. Nandan Nilekani, Economic Times, March 1

We are very keen to do more in these areas but we have our resource constraints. So we cannot do everything at one go. Manmohan Singh, Economic Times, March 1

Conclusion

Generous grants, compression, righteous rule and succour to the downtrodden are the hallmarks of good governance. P. Chidamabaram in his Budget speech

Contact Information av.vedpuriswar@ubs.com

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