Report No: AUS10373 October 2014 India Development Update India Development Update October 2014 Standard Disclaimer: . This volume is a product of the staff of the International Bank for Reconstruction and Development/ The World Bank. The findings, interpretations, and conclusions expressed in this paper do not necessarily reflect the views of the Executive Directors of The World Bank or the governments they represent. The World Bank does not guarantee the accuracy of the data included in this work. The boundaries, colors, denominations, and other information shown on any map in this work do not imply any judgment on the part of The World Bank concerning the legal status of any territory or the endorsement or acceptance of such boundaries. . Copyright Statement: . The material in this publication is copyrighted. Copying and/or transmitting portions or all of this work without permission may be a violation of applicable law. 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Recent Economic Developments .......................................................................................................... 1 1.1 Real sector activity ........................................................................................................................ 1 1.2 Balance of payments ..................................................................................................................... 2 1.3 Inflation ......................................................................................................................................... 4 1.4 Financial sector ............................................................................................................................. 6 1.5 Fiscal developments ...................................................................................................................... 9 1.6 Reform actions ............................................................................................................................ 11 2. Global developments .......................................................................................................................... 14 3. Outlook ............................................................................................................................................... 16 4. Supply Chain Delays and Uncertainty ................................................................................................ 19 This Update was prepared by Denis Medvedev (GTCDR), Saurabh Shome, Smriti Seth, and Jaba Misra (GMFDR) under the guidance of Vinaya Swaroop (Practice Manager, GMFDR), Zahid Hussain (Lead Economist, GMFDR), and P. S. Srinivas (Practice Manager, GTCDR) and on the basis of discussions with experts in New Delhi’s think tanks and policy making circles. Gunjan Gulati (CSASC), Neeti Katoch, Varsha Marathe, Anuradha Ray, and Niraj Verma (GFMDR) authored the financial sector analysis, while Tehmina Khan (DECPG) authored the global developments section. Luke Simon Jordan, Bertine Kamphuis, Aman Khanna, and Denis Medvedev (GTCDR) authored the special topic section. Onno Ruhl (Country Director, SACIN) and Marcelo Giugale (Senior Director, GMFDR) linked the team to the Bank’s overall strategy and steered them in that direction. The Updates are published twice yearly and give an overview of developments in the Indian economy in a global context, and also highlight topics related to medium- and long-term growth which are in the public debate at the time of writing. The special topic of this Update is the impact of supply chain delays and uncertainty on manufacturing growth. India Development Update October 2014 Executive Summary Growth rebounded significantly due to strong industrial recovery aided by growth in investment and exports. Capital flows are back, signaling growing investor confidence, as inflation has moderated from double digits, exchange rate has stabilized, and financial sector stress has plateaued. Monetary policy continuity has been maintained and there has been some progress on fiscal consolidation. With the economy still below potential and reform momentum picking up, growth is expected to strengthen over the medium-term. Inflation is expected to decline with monetary policy switching to inflation targeting while the current account deficit is expected to widen somewhat as import demand and capital inflows rise. Fiscal consolidation is expected to continue through stronger revenue mobilization. Downside domestic risks can be offset through accelerated structural reforms. Growth rebounded strongly in the first Inflation has moderated from double digits as quarter of fiscal year 2015 (Q1 FY2015) as food and fuel price growth has eased. industrial activity accelerated. While the Consumer inflation has been trending services sector continues to be the main engine downwards since January 2014 but remains of the Indian economy, growth improved to 5.7 elevated at 8.0 percent year-over-year. Despite percent year over year in Q1 FY2015 mainly easing momentum, growth in prices of food because industrial activity accelerated to 4.2 products outpaces price growth in other percent year over year, the fastest pace since Q4 categories. Upside risks stem from volatile FY2012. Activities related to construction, prices of certain food categories, especially electricity, gas and water supply grew robustly vegetable prices and a widening supply-demand and demand for capital and basic goods gap driven by changing consumer preferences. increased. Investment accelerated sharply to 7 Fuel inflation moderated due to declining global percent year-over-year in Q1 FY2014 from an crude prices that led to price corrections in bulk average growth of 0.3 percent year-over-year diesel and other oil distillates. since Q1 FY2013. Agricultural activity slowed in Q1 FY2014 as the untimely rains in March Faced with slowing credit growth and upside adversely affected the winter crop. risks to inflation, the Reserve Bank of India (RBI) kept the policy rates unchanged. Credit The current account deficit narrowed to pre- growth decelerated to 10.5 percent year-over- global crisis levels and capital inflows surged. year in August, continuing the declining trend The 18 percent depreciation in the rupee since March, 2014. In order to provide sufficient between May and August, 2013, and the liquidity in support of the economic recovery recovery in India’s major export markets helped while simultaneously remaining vigilant against stimulate export demand. Simultaneously, inflation, the RBI kept the policy repo rate restrictions on gold imports, stable global crude unchanged at 8 percent while lowering the prices, and rising import costs due to exchange Statutory Liquidity Ratio from 23 percent to 22 rate depreciation reduced imports. percent. Consequently, the Q1 FY2015 current account deficit came down to 1.6 percent of GDP, close Financial sector stresses have plateaued, but to pre-global crisis levels. Capital flows the sector’s overall health will need to be improved markedly as both portfolio watched closely. Though gross non-performing investments by Foreign Institutional Investors assets (NPAs) remain high, overall stressed (FIIs) and Foreign Direct Investment (FDI) assets are showing signs of containment with the increased, with the reserve coverage rising to banking sector focused on ensuring that further almost seven months of imports. Following last slippages into bad loans are arrested in a timely year’s depreciation episode, the exchange rate manner. However, profitability continues to be has remained stable and recovered more than strained as balance sheets of banks are still half of its losses from the lowest point. weighed down by impaired loans which could constrain their ability to raise capital in the medium term. The corporate sector is showing i India Development Update October 2014 signs of revival, supported by positive business implementation has been borne out in actions to sentiment, while the Indian stock market has expedite decision making and clearance outperformed developed and peer emerging procedures for large projects. New reform steps markets over the last six months. On the include actions to deregulate diesel prices, regulatory front, the RBI’s new guidelines reform labor laws, facilitate regulatory boosted the recovery mechanisms, such as sales compliance, simplify land acquisition and to asset reconstruction companies (ARCs). In the environmental clearances, and improve financial infrastructure space, the bulk contributor to inclusion. The authorities also raised FDI limits NPAs, recent measures saw relaxation of norms in key sectors and took measures to deepen to aid long term financing. financial markets. In addition, a new Expenditure Management Commission was The fiscal deficit of the central government established to rationalize public spending outperformed the target. The FY2014 fiscal (including subsidies), while the long-standing deficit came in at 4.6 percent of GDP, 0.2 Planning Commission will be disbanded in favor percent of GDP better than target. This was of an economic advisory body. achieved through a combination of expenditure compression—primarily in social services and Growth is expected to improve to 5.6 percent infrastructure—and larger non-tax revenues, in FY2015. India’s long-run growth potential including one-time telecom spectrum auction remains high due to favorable demographics, receipts and dividends from Coal India. While relatively high savings and policies and efforts revenues and grants reached 9.3 percent of GDP, to improve skills and education, facilitate the highest level in two years, they still lagged domestic market integration, and incentivize behind budget estimates. This trend has so far manufacturing activities. Under the baseline continued in the current fiscal, as weak tax scenario in this Update, growth is expected to revenue collection has resulted in the central rise to 5.6 percent in FY2015, followed by government incurring close to 75 percent of the further acceleration to 6.4 percent and 7.0 annual fiscal deficit in the first five months of percent in FY2016 and FY2017. Externally, the the year, compared with an average of 66.4 scenario is predicated on exports boost from percent for the same period in the previous three improving growth and job prospects in the years. United States and largely stable or declining crude prices. External shocks, including Subsidy spending exceeded the budgeted financial market disruptions arising out of amount in FY2014, but the FY2015 subsidy changes in monetary policy in high income burden is likely to ease. In FY2014, subsidy countries (particularly in the United States), expenditures came in at 2.3 percent of GDP, slower global growth, higher oil prices, and exceeding the budgeted target by 0.3 percentage adverse investor sentiment arising out of geo- points. This occurred largely due to greater-than- political tensions in the Middle East and Eastern budgeted oil subsidies, despite rolling over 0.3 Europe could have adverse consequences for the percent of GDP worth of subsidies from FY2014 baseline trajectory. Domestically, risks include to FY2015. Although this move left little space challenges to energy supply and fiscal pressures for subsidy spending in FY2015, a decline in from weak revenue collection in the short term global oil prices and gradual increases in the and the Seventh Pay Commission’s domestic price of diesel have pushed under- recommendations on public sector remuneration recoveries on diesel to zero by mid-September in the medium term. On the other hand, further 2014. The announced deregulation of diesel in progress on the reform agenda—particularly the October 2014 will limit further liabilities and implementation of the Goods and Services Tax keep the oil subsidy bill contained, most likely (GST), which could transform India into a below 0.6 percent of GDP. common market and dramatically boost competitiveness—could help offset both The reforms pace has gained momentum. The domestic and external risks to the outlook. authorities’ focus on efficient and effective ii India Development Update October 2014 Supply chain delays and uncertainty are a major, yet underappreciated, constraint to manufacturing growth and competitiveness. Regulatory impediments to the movement of goods across state borders raise truck transit times by as much as one quarter, and put Indian manufacturing firms at a significant disadvantage vis-à-vis international competitors. State border check-points, tasked primarily for carrying out compliance procedures for the diverse sales and entry tax requirements of different states, combine with other delays to keep trucks from moving during 60 percent of the entire transit time. Long transit times and high variability and unpredictability in shipments add to total logistics costs in the form of higher-than-optimal buffer stocks and lost sales, pushing logistics costs in India to two- three times international benchmarks. Implementation of the GST, combined with dismantling of inter-state check-posts, is the most crucial reform that could improve competitiveness of India’s manufacturing sector. The GST offers a unique opportunity to rationalize and re-engineer logistics networks in India, given the inherent inefficiencies with taxes based on the crossing of administrative boundaries. The GST will free up decisions on warehousing and distribution from tax considerations so that operational and logistics efficiency determines the location and movement of goods. Freight and logistics networks will realign according to the location of production and consumption activities, creating the hub-and-spoke models that are needed to improve freight and logistics performance. Simply halving the delays due to road blocks, tolls and other stoppages could cut freight times by some 20-30 percent and logistics costs by an even higher 30-40 percent. This would be tantamount to a gain in competitiveness of some 3-4 percent of net sales for key manufacturing sectors, helping India return to a path of high growth and enabling large-scale job creation. iii India Development Update October 2014 contracted by 1.1 percent saar in Q1 FY2015. 1. Recent Economic Developments Going forward, deficient rainfall in the ongoing monsoon season is likely to lower agricultural 1.1 Real sector activity growth in the current fiscal—affecting both the Growth accelerated in the first quarter of summer (Kharif) and the winter (Rabi) crop FY2015 (Q1 FY2015) as industrial activity cycles. picked up.1 Real GDP growth at factor cost improved to 5.7 percent year-over-year, the fastest pace in the past eight quarters, while on a quarter-over-quarter seasonally adjusted annual rate (saar) basis the pick-up was even sharper at 6.1 percent. The acceleration was mostly due to a sharp uptick in industrial activity that grew at 4.2 percent year-over-year after contracting for two previous quarters and registering an average growth of 0.7 percent year-over-year since Q1 FY2013. The acceleration amounted to a near- quadrupling of the industrial sector’s contribution to growth, which rose to 19.7 percent in Q1 vs. an average of 5.6 percent since FY2013. The services sector grew at 6.5 percent Industrial activity rebounded sharply. After saar, continuing its earlier trend, while contracting in the last two quarters of the agricultural growth moderated. previous fiscal year, industrial growth accelerated to 4.2 percent year-over-year, the highest outturn in the last eight quarters. The uptick was broad based across all sectors, with mining and manufacturing growth expanding after two quarters of contraction. Construction activities that had almost stagnated in the previous two quarters accelerated, while growth in electricity, gas and water supply soared to double digits— a pace last witnessed between July and September, 2011. Investment growth picked up sharply to 7 percent year-over-year in Q1, the fastest in eight quarters. Demand for capital goods and basic goods grew at a healthy pace, especially capital goods that accelerated to Agricultural growth lost momentum as the double digits (13.6 percent) from negative winter crop suffered from untimely rains. growth in the previous quarter. The sharpest Due to a good monsoon season in 2013, growth was in machinery and equipment, led by agricultural growth reached 10 percent saar in strong growth in electrical machinery and the last quarter of FY2014. However, despite apparatus, required predominantly in the sufficient levels of soil moisture and recharged manufacturing sector. On the other hand, reservoirs, winter crop (Rabi) yields suffered demand for equipment required primarily in the due to untimely rains and hailstorm in March services sector such as office and computing 2014, which affected the standing crop, machinery and communication equipment, especially in the states of Maharashtra, Madhya contracted. Similarly, demand for basic metals Pradesh and Punjab. Consequently, agriculture picked up to 11.4 percent from below 4 percent in the previous quarter. Demand for consumer 1 Throughout the document, FY2015 refers to fiscal goods remains depressed with the quarterly year ending March 31, 2015. average year-over-year growth for consumer 1 India Development Update October 2014 durables continuing to contract while that for US$11.2 billion, reaching US$316 billion or 6.9 non-durables stagnating below 1 percent. months of imports. The current account is returning to pre- global crisis levels. The current account balance transitioned through several shifts over the past decade, deteriorating from a surplus of 0.3 percent of GDP in the five years before the global crisis (FY2004-2008) to an average deficit of 3.3 percent of GDP during FY2009- 2013. However, following the rupee depreciation in the summer of FY2014, the current account deficit narrowed to a near decade-low of 0.2 percent of GDP in Q4 FY2014 due to improved export competitiveness and a sharp contraction in imports. As Q1 The services sector continued to be the main FY2015 showed some signs of revival in import driver of growth. The services sector, which demand, the current account deficit widened, but accounts for more than half of GDP, grew at 6.5 remained low and near pre-crisis levels. percent saar in Q1 FY2015, consistent with the Movements in the current account deficit have trend average of 6.6 percent saar since Q2 closely mirrored the merchandise trade gap FY2012 but well below the double digit growth which narrowed from 10.5 percent of GDP in rates witnessed between 2009 and 2011. On a FY2013 to 7.8 percent in FY2014, and further to year-over-year basis, the services sector grew at 7.3 percent in Q1 FY2015. 5.7 percent year-over-year in Q1 FY2015, accounting for 4.1 percentage points of the 5.7 percent GDP growth in Q1 FY2015. The largest contributors, financing, insurance and real estate services, accounted for 2.2 percentage points— followed by community, social and personal services, all of which contributed 1.1 percentage points. 1.2 Balance of payments India’s external balances improved as the current account deficit narrowed and capital inflows surged. Muted merchandise imports coupled with continued improvement in global Sharp decline in imports helped close the export demand helped contain the current merchandise trade gap. Merchandise imports account deficit at 1.6 percent of GDP in Q1 contracted by 7.2 percent during FY2014, as the FY2015. While higher than the 0.8 percent of nearly 20 percent depreciation of the rupee in GDP average over the last three quarters, this the summer of 2013 pushed up import costs and result was well below the FY2014 deficit of 1.7 led to a contraction in import demand2. percent of GDP. Foreign investment inflows Furthermore, gold, which accounted for 11 (direct and institutional) regained strength and increased to 4.3 percent of GDP during Q1 2 The trade balance worsened initially as imports FY2015 from 1.4 percent during FY2014. As a were inelastic in the short run while exports took result, the overall balance of payments improved some time to respond. After the initial deterioration, and foreign reserves in Q1 increased by however, the trade balance improved as exports volumes rose while imports volumes declined, following the J-curve effect. 2 India Development Update October 2014 percent of total imports in FY2013, declined by United Kingdom grew at 13.5 percent on 47 percent in FY2014 after authorities raised account of increased petroleum and metal duties and imposed quantitative restrictions on exports, which together account for 20 percent its imports. In addition to gold, the decline was of all shipments to the country. On the other driven by capital goods and iron and steel hand, exports to seven other major EU countries imports which shrunk by 11 percent and 26 remained largely unchanged with a growth of percent during FY2014. However, import 0.3 percent during FY2014.3 demand increased somewhat during Q1 FY2015 in line with the overall economic recovery. The The shift in the export destination of refined decline in merchandise imports moderated from petroleum products drove the changes in 13.6 percent during the second half of FY2014 overall export trends. Refined petroleum is to 6.5 percent year-over-year during Q1 India’s largest export at 20 percent of the total. FY2015. In FY2014, the share of refined petroleum exports to the United States, the United Kingdom, and Japan increased from 7.7 percent in FY2013 to 12.7 percent and constituted the primary driver of increased export demand from these countries. Conversely, originally large recipients, Netherlands and France, mirrored that increase with a sharp decline, from 13 percent of total petroleum exports in FY2013 to 8 percent in FY2014. Gold jewelry exports fell by 24 percent due to restrictions on imports of raw gold. Exports to the United Arab Emirates, India’s second largest export destination, fell by 16 percent due to a 32 Export growth strengthened on account of percent reduction in jewelry exports. However, improved global demand. Merchandise exports some of the decline in jewelry was offset by a 12 grew by 3.9 percent in FY2014 and strengthened percent increase in diamond exports, mainly to further to 10.6 percent in Q1 FY2015— driven the United States and Hong Kong. primarily by more robust demand from the United States, the United Kingdom, Japan and China which, together, account for 22 percent of all exports. As economic conditions improved in the United States, India’s largest export destination (12.5 percent of all merchandise exports), shipments grew by 8 percent during FY2014 and further by 6.4 percent year-over- year during Q1 FY2015. Exports to the United States primarily consist of precious metals and jewelry (20 percent), textiles and footwear (18 percent), machines and transport equipment (11 percent) and petroleum (10 percent). Simultaneously, commensurate with the European Union’s slower economic recovery, exports to EU countries registered a growth of 2.3 percent during FY2014, compared to -4 3 Belgium, France, Germany, Italy, Netherlands, percent in the previous year. However, countries Russia and Switzerland account for 86 percent of within the European Union performed total exports to the European Union (excluding the differently: on the one hand, exports to the United Kingdom). 3 India Development Update October 2014 Growth in portfolio flows and foreign direct when the actual Fed tapering began in December investment ensured adequate financing of the and further moves by the Fed had little impact current account deficit. In Q1 FY2015, capital on the exchange rate. The real effective inflows increased markedly to 3.7 percent of exchange rate (REER) mostly mirrored the GDP from 2.4 percent during FY2014. This movement of the nominal exchange rate and increase was supported primarily by higher FII appreciated by 6.4 percent since August 2013, inflows which rose to 2.6 percent of GDP from but remained more competitive than before the 0.3 percent as global investor sentiment depreciation episode due to moderation in improved. FDI inflows also benefitted from big domestic inflationary pressures. investments by Vodafone (US$1.5 billion) and Abbott (US$450 million) and increased to 1.7 percent of GDP during Apr-Jun 2014 from 1.1 percent during FY2014. Non-resident Indian (NRI) deposits, which surged to 2.1 percent of GDP during FY2014 in response to steps taken by RBI to liberalize currency swaps in September 2013, returned to their average historical level of around 0.5 percent of GDP. 4 External debt rose on higher deposits by non- resident Indians. During FY2014, total external obligations rose by 7.6 percent to US$440.6 billion or 23 percent of GDP. The increase was primarily due to a 47 percent increase in NRI deposits, reflecting the impact of fresh deposits mobilized under the currency swap scheme during September-November 2013 by the RBI. However, short-term obligations improved: debt due for maturity within one year declined to The currency has regained strength following US$114 billion (37.5 percent of foreign last summer’s bout of depreciation. Similar to exchange reserves), or 6 percent of GDP from other emerging markets, the rupee depreciated 6.2 percent of GDP the previous year. Sovereign by 18 percent between May and August 2013 as external debt registered a small decline to global investors fretted over fears of early Fed US$81.5 billion or 4.3 percent of GDP at the end tapering. Since then, the rupee recovered by of March 2014, from US$81.7 billion or 4.4 more than 9 percent and stabilized around percent of GDP a year ago. Multilateral or INR60/US$ as global market fears subsided, bilateral credit continued to account for nearly growth in high income economies continued to 80 percent of overall sovereign debt. improve, and the current account deficit narrowed. Due to improved external balances, 1.3 Inflation India was better insulated from further shocks Consumer inflation has fallen to a record low of 6.5 percent due to easing food prices. 4 The RBI provided a facility for Indian banks to Following an uptick in July, consumer inflation swap forex liabilities against Foreign Currency Non- declined to 6.5 percent year-over-year in Resident, Bank (FCNR B) deposits at a fixed cost of September, the lowest outturn in the four year 3.5 percent per annum, compared to market rates of history of the new Consumer Price Index. around 6-8 percent in September 2013. 4 India Development Update October 2014 Despite the deceleration, inflation nonetheless The decline in global crude prices eased remains relatively high, averaging 8.0 percent pressures on fuel prices. Drop in the global year-over-year since January 2014. Food prices crude oil prices has led to a moderation in fuel continue to be the main contributor to the rate of inflation to an all-time low of 3.5 percent year- inflation as well as the recent slowdown: in over-year in August 2014. Similarly, wholesale FY2015, prices of food have grown at an inflation in fuel and power fell sharply to 4.5 average rate of 9.0 percent and have contributed percent year-over-year in August 2014, after 52 percent to overall inflation, more than its 50 averaging 9.5 percent since January 2013 when percent weight in the overall CPI. authorities began the selective deregulation of diesel prices for bulk consumers and allowed a phased administered price increase for retail consumers.5 The largest contribution to the slowdown came from moderating bulk diesel, petrol and naphtha prices. However, upside risks remain from global commodity prices in view of the ongoing instability in the Middle-East. Food price growth remains high and volatile. Within food, cereals have been the largest contributor, primarily due to their larger weight in the consumption basket. However, other prices have been growing much more rapidly, with vegetables, fruits, and milk and milk products registering double-digit price growth. Since January, growth in milk and vegetable prices has contributed 0.9 and 0.8 percentage The central bank kept the policy rate points, respectively, to the average overall unchanged while easing liquidity provisions inflation of 8.0 percent. While the contribution to support credit growth. The downward trend of vegetable prices to overall inflation has been in inflation appears to be on track to meet the volatile (the July uptick in inflation was mostly recommendations of the RBI panel report on a due to a spike in vegetable prices), that of milk, new approach to monetary policy (Box 1). milk products and fruits has been on a steady However, upside risks remain from volatility in rise since mid-2013. the prices of some food groups, especially vegetables, fruits and milk. Cognizant of a delicate balance between remaining vigilant against inflation and supporting the nascent economic recovery, the RBI has kept its policy rates unchanged at 8 percent after raising it by 75 basis points in January 2014. Instead, the central bank chose to ease reserve norms to free up resources for expanding bank credit. Overall credit growth has continued to decelerate since March 2014, falling to 10.5 percent year on year 5 Bulk users consume approximately 18 percent of the total diesel consumption in India. 5 India Development Update October 2014 in August this year from 16 percent last year. took steps to contain the NPAs in the Consequently, the RBI lowered the Statutory infrastructure sector, which contribute to almost Liquidity Ratio (SLR)6 of commercial banks on half of the total stressed assets of banks.7 two occasions—May and July—correcting it by Further, industry reports suggest that the 50 basis points each time from 23 percent to 22 proportions of loans in sectors with negative percent of their Net Demand and Time outlook shrank while loans to sectors with stable Liabilities (NDTLs). Simultaneously, liquidity outlook increased in FY2014.8 provisions were revised to improve monetary policy transmission; access to funds under the Liquidity Adjustment Facility (which is available at the prevailing repo rate) was raised by 25 basis points to 1 percent of NDTLs, and commensurate restrictions imposed on other provisions, to maintain overall liquidity. Stronger corporate balance sheets have been one of the main drivers behind improvements in asset quality. About 70 percent of aggregated balance sheet debt of BSE500 corporates (excluding financial services) belongs to net importers and the rupee appreciation improved the credit metrics of these companies.9 Another 1.4 Financial sector industry analysis of 2,500 listed corporates indicated a modest improvement in the interest Despite recent improvements in asset quality, coverage ratio from 2.3 in FY2014 to 2.5 in Q1 non-performing assets remain high. Lower FY2015– the first such improvement in 16 slippages, a seasonal pattern of higher recovery, quarters.10 An RBI survey of non-government write-offs during the last quarter of FY2014, and non-financial companies also indicates similar sales of NPAs to ARCs contributed to some trends in terms of decline in interest expense and improvement in asset quality. As a result, gross improvement in interest coverage. However, NPAs (GNPAs) in the banking sector declined overall sales and operating profits of the to 4.0 percent in Q4 FY2014 from 4.4 percent at corporates, except information technology (IT) the end of the previous quarter, although they firms, saw a contraction. remain well above 3.4 percent recorded at the end of FY2013. Overall stressed assets, which include restructured standard advances, also came down from 10.2 percent of total advances in Q2 FY2014 to 9.8 percent in Q4 FY2014. Though GNPAs increased marginally between 7 March and June 2014, there has been a India Development Update March 2014 discussed significant drop in fresh referrals to the infrastructure sector’s contribution to NPAs of SCBs 8 Corporate Risk Radar, 2014-2015, India Ratings Corporate Debt Restructuring (CDR) Cell for and Research, June 2014 restructuring in this period. The authorities also 9 S&P BSE 500 index represents nearly 93% of the total market capitalization on the Bombay Stock 6 SLR is the minimum percentage of deposits in Exchange, covering 20 major industries. 10 approved securities that banks must maintain. Nomura Corporate Health check – June 2014 6 India Development Update October 2014 Box 1: Key recommendations of the Expert Committee to Revise and Strengthen the Monetary Policy Framework The report of the Expert Committee to Revise and Strengthen the Monetary Policy Framework is organized in four principal parts, each part dealing with the subject of the nominal anchor, the organizational structure for taking monetary policy decisions, changes to the operating framework, and removing hurdles to monetary policy transmission. The choice of the CPI (combined) as the nominal anchor is likely to enhance policy communication and hence expected to more effectively affect inflation expectations and improve monetary policy transmission. A committee based organizational structure, with enhanced research support, aims at reducing discretionary policymaking. The operating framework recommendations strive to reduce volatility and reduce the RBIs role in government financial management. Finally, removing hurdles to policy transmission are a mix of recommendations for reducing financial market distortions arising out of government policy and actions and enhancing conventional monetary safeguards in a global context. Nominal anchor: The report recommends that inflation should be the nominal anchor for monetary policy framework, measured by the new CPI (Combined) index. The recommended nominal target is 4 +/- 2 percent, to be adopted after a phased inflation reduction plan targeting 8 percent inflation in the first 12 months and 6 percent inflation in the following 12 months. Although close to 50 percent of the weight in the index pertains to food and fuel—commodities for which monetary policy has limited direct effect—research suggests that inflation expectations are more closely correlated and tend to persist longer with CPI inflation than WPI. Organizational structure: The report proposes that monetary policy decision-making be vested in a five- member Monetary Policy Committee (MPC) composed of the RBI Governor (Chairman), the Deputy Governor in charge of Monetary Policy (Vice Chairman), and three members: the Executive Director in charge of Monetary Policy and two external members chose by the Chairman and Vice Chairman. The MPC will vote on the policy and will be accountable for failing to meet the inflation target for three consecutive quarters. In order to support MPC decision-making, the RBI’s Monetary Policy Department will be significantly reorganized to enhance research support. Operating Framework: The report proposes that the MPC target a positive real policy rate, keeping in mind the output gap. In Phase I of the implementation of the new framework, the currently used overnight Liquidity Assessment Facility (LAF) repo rate will continue as the policy rate but it will be restricted to a specified ratio of bank-wise Net Demand and Time Liabilities (NDTL). Concurrently, as the 14 day term repo rate stabilizes, it will to be used increasingly to provide liquidity to banks with the aim of transitioning the 14 day term repo rate as the policy rate. In Phase II, as the 14 day term repo rate gains acceptance, it will replace the overnight repo rate as the policy rate. The RBI expects that 14 day term repo rate will improve monetary policy transmission by discouraging the use of the overnight repo rate as the first liquidity management option by banks thereby assisting in the development of markets that price and hedge risks. Simultaneously, the MSF rate will be set high enough to be perceived and consequently used as a facility to be used only in exceptional circumstances. The framework also proposes that debt and cash management of the government to be under the Government and not the RBI, and instruments such as the Market Stabilization Scheme (MSS), Cash Management Bills (CMB), and Sector-specific refinancing will be phased out. Finally, the framework suggests reducing the Statutory Liquidity Ratio (SLR) in keeping with BASEL III framework, minimizing government intervention in commercial banks, detaching open market operations from fiscal operations, and having greater forex reserves and instruments to deal with inflows and outflows. Bank profitability continues to be under on equity declined in FY2014 as banks faced pressure even as authorities roll out a large lower profitability coupled with fresh capital financial inclusion program. The return on infusion requirements following the roll-out of assets remained similar to last year while return Basel III norms in April 2013. Weak financial 7 India Development Update October 2014 performance of public sector banks is evident in raising the Security Receipts (SR) invest and their contributing just 41 percent of the total hold threshold from 5 percent to 15 percent. profit after tax (as compared to over 65 percent Nevertheless, trends in asset sales through SRs in 2010), even though their share in total will need to be watched from the perspective of banking sector assets is around 70 percent. As a banks using it to mask existing vulnerabilities. result of continued stresses in the banking system, bank credit growth declined to 13.6 percent by the end of FY2014 from 15.1 percent at the end of the previous fiscal. Under these conditions, the ability of Indian banks to service large volumes of low-income customers, as envisaged under the recently launched comprehensive financial inclusion campaign (see section 1.6), may be limited by several factors such as the burden of bad loans, lower profitability, need for higher capital, and existing priority sector obligations. Other initiatives to reduce the NPA burden have had more limited success. Another mode of recovering bad loans through The Securities and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act, 2002, which allows banks and financial institutions to auction properties when borrowers fail to repay loans, has recovered only 27 percent of the INR681 billion worth of loans referred to it.12 However, RBI’s constant nudges for proactive action have stirred some banks to take severe measures. United Bank of India’s Recent RBI guidelines on NPAs have resulted recent declaration of the Chairman of United in significant increases in sales to ARCs. In Breweries Group a ‘wilful defaulter’ may set the context of the deterioration in the asset pace for other banks to undertake serious quality of banks, recent RBI guidelines propose measures for debt enforcement.13 a corrective action plan that offers incentives for early identification of stressed assets by banks, New infrastructure bonds could increase the timely revamp of accounts considered to be availability of long term financing for credit- unviable, and prompt steps for recovery or sale strapped infrastructure. Loans to stalled of assets in the case of loans which are likely to infrastructure projects continue to drag down the turn NPAs. Consequently, banks (especially the books of Indian banks while financing for new public sector banks) have increased their sales of projects remains limited. To address this issue, NPAs, to ARCs over the last few quarters.11 the RBI has now allowed banks to raise long Loan sales rose to an estimated 0.2 percent of term funding (tenor >7 years) for lending to total advances in March 2014 from a mere 0.01 infrastructure with minimum regulatory pre- percent six months prior; moreover, even after adjusting for ARC sales, total stressed assets 12 Operation and Performance of Commercial Banks, RBI, appear to have plateaued. Going forward, the November 2013 sale of NPAs to ARCs could decline with RBI, 13 RBI guidelines indicate that once tagged as wilful defaulters, business people can be barred from accessing India’s financial markets and kept out of influential 11 RBI’s Financial Stability Report, June 2014 corporate positions. 8 India Development Update October 2014 emption (no cash reserve ratio, statutory like mutual funds, will also be compulsorily liquidity ratio, or priority sector lending). listed on the bourses, thus providing liquidity to Because of the relief in reserve requirements and investors. The success of the new instruments priority sector credit target, such bonds could will depend on the ability of the financial sector cost 60-100 basis points less than traditional to operationalize them quickly, as well as on the CDs/short term deposits.14 Market expectations development of an ecosystem of domestic and of this policy indicate large debt market overseas investors in long tenor infrastructure issuances in the Indian market.15 Assets worth finance. INR2.7-3.5 trillion could qualify for such funding in FY2015, depending on the interest Despite new initiatives, power sector finance rate differential between term deposits and bond remains a challenge. Power sector finance rates. Insurance companies, pension and accounts for 59 percent of the banking sector’s provident funds, FIIs, and retail investors are nearly INR9 trillion exposure to infrastructure likely to be the early investors. However, the and could be adversely affected by recent cushion available with insurance companies and Supreme Court rulings, including the allocation pension funds for investments in corporate of coal blocks and the compensatory tariff for bonds is estimated to be less than INR1 trillion, two large thermal projects that use imported which may emerge as a constraining factor for Indonesian coal.17 In deciding on the latter, the long-term bond issuances by banks. Thus, Supreme Court stayed a July 2014 order by the significant improvement in FII’s investment Appellate Tribunal for Electricity (APTEL) that appetite would hold the key for utilization of the allowed Tata Power Co. Ltd and Adani Power initiative’s full potential. Ltd to charge higher prices for electricity produced from their plants in Mundra, Gujarat. Innovative financing vehicles are another In 2012, the Indonesian government changed potential source of funding for infrastructure. rules and linked the prices of coal exports to spot The authorities have introduced new market prices, which made ineffective Infrastructure Investment Trusts (IInvTs), to be provisions of long-term contracts signed by established along the lines of Real Estate Indian firms with Indonesian miners. Such Investment Trusts (REITs) to create new developments point to challenges in investor classes in infrastructure and enable infrastructure project procurement, including in banks to offload post commissioned assets to the design of contracts, and remain a key feature such IInvTs. These trusts will invest public for policy to address. money into completed and revenue generating infrastructure projects, while investments in 1.5 Fiscal developments projects under construction will be limited to 10 The central government’s FY2014 fiscal percent of assets.16 Banks, international deficit came in better than the target. The multilateral financial institutions, foreign FY2014 overall gross fiscal deficit was 4.6 portfolio investors (FPIs), including sovereign percent of GDP, an improvement from the 4.8 wealth funds, can come in as strategic investors percent recorded in FY2013 and the budgeted in IInvTs. The units issued by these trusts, just target of 4.8 percent of GDP for FY2014. Although the deficit remains well above the 3.4 14 The spread could fall to 30-70 basis points if interest rate percent of GDP average of FY2005-FY2008 and differential between short-term deposits and long-term continues to exceed the adjustment path bonds were to widen. A recent bond transaction (Andhra proposed by the Thirteenth Finance Bank rated AA+ by CRISIL, INR10 billion Infrastructure Bonds), one of the first in the market post the new rules to Commission, it has now declined for two be rated, is expected to cost 75basis points lower relative to consecutive years, reflecting the authorities’ long tenor deposits, on account of the special features of commitment to fiscal consolidation. such instruments. 15 ICRA Comments July 2014 16 Counterpart funding would have to come from private 17 placements in cases when projects under construction Tata Power and Adani Power, both plants in account for more than 10 percent of assets. Mundra Gujarat 9 India Development Update October 2014 Revenues were the highest in two years, but exceeded the budgeted amount of INR650 lagged behind budget estimates. In FY2014, billion (0.6 percent of GDP) by more than total revenues and grants were at 9.3 percent of INR200 billion (rising to 0.8 percent of GDP). GDP, the highest outturn since FY2011.18 Even This amount does not include INR 350 billion in so, all tax revenues (corporate, income, service, oil subsidy spending which the authorities excise, and customs duties) remained below announced would be rolled over to the next levels budgeted a year ago. The revenue fiscal year; counting the roll-over as FY2014 shortfall, however, was somewhat compensated expenditure would push the oil subsidy bill to by unanticipated non-tax revenues which 1.1 percent of GDP.19 exceeded the target of 1.5 percent of GDP by 0.2 percentage points: INR611 billion (0.2 percent of GDP) telecom spectrum auction windfall and INR164 billion dividend from Coal India (0.1 percent of GDP). Subsidy spending has moderated in FY2015 as diesel prices reached parity with international levels. Due to declining global oil prices, cost of domestic diesel production has Expenditure restraint was achieved largely remained below international prices since mid- through cuts in social services and September 2014. This has kept fuel subsidies infrastructure. Current expenditures were contained and allowed the authorities to take the contained at 12.4 percent of GDP, 0.2 percent of critical step of deregulating retail diesel prices in GDP below budget but 0.1 percent of GDP October 2014. Even prior to the reform, FY2015 higher than in FY2013. Similar to the under-recoveries by oil marketing companies adjustment at the end of FY2013, the cuts in were expected to decline by 35 percent from the current expenditures are mostly in social previous year.20 Since approximately half of services, particularly in rural development, these under-recoveries are borne by the health and education. The largest cuts in capital government, fuel subsidies could decline to 0.6 expenditure were in telecommunications, power, percent of GDP or lower in FY2015 (including and roads. 19 Similar to prior years, subsidy expenditures Note that FY2014 spending on oil subsidies also exceeded budget estimates. The authorities includes INR450 billion in roll-over from FY2013. spent 2.3 percent of GDP on subsidies, 0.3 The practice of rolling over oil subsidy spending is percentage points higher than the budgeted uncommon and no information is available on any amount. Most of the increase came from higher roll-overs prior to FY2013. Moving the expenditure spending on petroleum subsidies, which to the fiscal year in which it was incurred would imply the following overall subsidy bill: FY2013 3.0 percent of GDP, FY2014 2.2 percent, FY2015 1.7 18 Discounting the exceptional non-tax revenue of 2.8 percent (vs FY2013 2.5 percent, FY2014 2.3 percent, percent of GDP in 2011, this would mark the best FY2015 2.0 percent as reported in the budget). 20 revenue performance since the end of the global According to the press release dated September 01, financial crisis. 2014 by the Ministry of Petroleum and Natural Gas. 10 India Development Update October 2014 the roll-over of INR350 billion from FY2014), spending was due to higher social services compared to 0.8 percent of GDP in FY2014. expenditures on education, sports, arts and culture (by Punjab, Bihar, Uttar Pradesh and Continued weakness in tax revenues could Tamil Nadu) and urban development (by put pressure on the FY2015 deficit target. Rajasthan, Bihar, Karnataka, Jharkhand, According to the Controller General of Chhattisgarh, Tamil Nadu and Haryana). Accounts, the central government incurred a fiscal deficit of 3.1 percent of GDP during the General government debt registered a minor first five months of FY2015, equivalent to 74.9 decline. The ratio of general government’s debt- percent of its fiscal deficit target for the year. In to-GDP fell by more than 10 percentage points comparison, over the last three years, authorities in the second half of the 2000s to near 67 ran an average deficit of 66.4 percent of the total percent, but did not decline further in FY2012- budget estimate during the same period. A FY2013 as economic growth slowed. In significant portion of the shortfall can be FY2014, the central government’s liabilities are attributed to lower tax collection, in spite of estimated to have decreased to 50.6 percent of some revival in economic activity: the central GDP from 51.7 percent in the previous year. government collected just 19 percent of its total Combined with marginal decline in the states’ budgeted tax revenue between April and August debt-to-GDP ratio, general government debt is 2014, compared with 22 percent of budget expected to fall slightly to 66.4 percent of GDP estimates over the same period last year. Excise from 66.9 percent in the previous year. revenues, which usually vary with manufacturing activity, declined by 3.6 percent 1.6 Reform actions year-over-year between April and August 2014 The reform momentum has accelerated. The in spite of a 2.6 percent saar increase in authorities have picked up the pace on the manufacturing output in Q1 FY2015. Similarly, reform agenda while maintaining focus on customs duties showed no year-over-year efficient and effective implementation. In recent percentage improvement, notwithstanding the major steps, the authorities have deregulated revival in import demand. However, divestment retail diesel prices, simplified labor compliances receipts are expected to pick up the pace during and streamlined inspections, and announced a the coming months as the Cabinet recently new mechanism for allocating coal blocks. Other cleared stake sales worth INR434 billion (0.3 important actions include steps to facilitate land percent of GDP) in the Oil and Natural Gas acquisition and environmental clearances, Corporation (ONGC), Coal India and the strengthening financial regulations, opening hydropower utility company NHPC Limited. defense and railways to FDI, and expanding financial inclusion. Fiscal consolidation among the states remains mostly on track. The combined fiscal deficit of The Union Budget did not compromise on all states increased to 2.3 percent of GDP during fiscal consolidation to support growth and FY2013, compared to the budget estimate of 2.1 committed to pushing ahead on reforms. The percent of GDP. However, even with the new administration’s first budget reaffirmed increase, the states remain below the deficit commitment to fiscal consolidation targets and targets recommended by the Thirteenth Finance announced the setting up of an Expenditure Commission. Total revenue collection rose Management Commission to review public above the budgeted target of 13 percent of GDP spending and propose steps to reduce subsidy to 13.3 percent of GDP, a historical high, expenditure (see Box 2). The authorities have primarily due to own-tax revenues from value- also signaled a policy shift towards a reduced added tax (VAT) and property transactions. role for central planning, announcing the However, this improvement was more than imminent dissolution of the central Planning offset by higher development expenditures and Commission, set up in 1950, to be replaced with capital outlay, which grew to 10.8 and 2.3 an economic advisory body to guide percent of GDP. Most of the increase in development policy thought. 11 India Development Update October 2014 Box 2: Reform measures in Union Budget 2014-15 The Union Budget FY2015 announced a series of steps to remove immediate growth bottlenecks and establish stronger foundations for long-term growth. Some highlights include: • Business environment: All business and investment clearances on a single online portal with an integrated payment gateway by December 31; single window customs clearance. • Energy: Steps to improve coal production and linkages; extension of the tax holiday on investments in power to 2017; transmission feeder separation in rural areas. • Infrastructure: Formation of the National Industrial Corridor Authority and a new institution (3PIndia) to support mainstreaming of PPPs; launch of tax-favorable Infrastructure Investment Trusts; development of 16 new ports, new inland waterways, and new airports in Tier-2 cities; funds for metros in Lucknow and Ahmedabad, and additional funds for railways in border areas. • Cities: Major expansion of the pooled municipal debt obligation facility for urban infrastructure and development of 100 new smart cities to ease pressure on major urban nodes. • Skills and access to finance: A new “Skill-India” program to support training and building entrepreneurial skills; harmonization of know-your-customer (KYC) norms across the financial sector, and a new fund to support start-up MSME companies. • Agriculture: A new program to improve access to irrigation; increasing warehousing capacity; and efforts to set up a national private agriculture market by reviewing state Agriculture Produce Marketing Committee Acts. • Expenditure management: A new expenditure management commission to be set-up to review public expenditures and subsidies. The commission will submit its report within one year. • Environment: Setting up of the Ganga Conservation Mission; new” ultra mega” solar power projects in four states and support to domestic solar panel/wind mill manufacturers. Decision making and clearance procedures international prices and domestic cost of for large projects have been expedited. All production was achieved in mid-September Groups of Ministers and Empowered Group of 2014, which allowed the authorities to take a Ministers that were charged with deliberating critical step of deregulating retail diesel in upon and taking major decisions were disbanded October, thereby eliminating the largest in May 2014, placing authority and component of the fuel subsidy burden. accountability directly on the line Ministries. At the procedural level, single window clearance Labor reforms and skills development have systems have been established to hasten large taken center stage. Regulations relating to capital intensive steel, coal and power projects. compliance with central labor laws have been eased and made more transparent. Firms can Diesel prices have been deregulated. In now comply with 16 central labor regulatory January 2013, the authorities deregulated prices requirements by filing a single return through an of bulk diesel and permitted oil marketing online portal. Further, selection of firms for companies to raise the prices of retail diesel by compliance inspections by central labor approximately INR0.50 per month to gradually inspectors has been made transparent- based on eliminate diesel under-recoveries (i.e., the a random computer generated sample of difference between the cost of production and registered firms. However, since labor is a international price). The parity between concurrent subject in the Constitution, these 12 India Development Update October 2014 regulatory changes are likely to have a partial projects respectively, (ii) restricting the need for impact since they only apply to enforcement a social impact assessment to only large or PPP agencies and industrial sectors under the projects, (iii) modification of the ‘retrospective purview of the central Ministry of Labor and clause’ which stipulates the lapse of land Employment. On the legislative side, the Union acquisition in case of non-payment or non- Cabinet cleared amendments to The Factories possession, and (iv) reviewing the definition of Act, 1948, the Apprentices Act, 196121 and ‘affected families’ for resettlement benefits. Labor Laws Act, 1988, for Parliamentary approval. These amendments, if they come into Environmental clearances will be streamlined force, will further reduce the regulatory burden via legislative and executive steps. A on firms, encourage apprenticeship, enhance committee has been set up in August with a two employee safety, and reduce eligibility month deadline, to review and suggest changes thresholds for receiving employee benefits. But to major environment laws – the Environment central legislative efforts will require (Protection) Act, 1986, Forest (Conservation) complementary legislative changes in state labor Act, 1980, Wildlife (Protection) Act, 1972, the laws. Some states have embarked on such Water (Prevention and Control of Pollution) Act, reforms. The Rajasthan state legislature 1974, and the Air (Prevention and Control of approved similar amendments to four state labor Pollution) Act, 1981. At the executive level, laws while other states contemplating similar orders have been passed to ease environment changes include Uttar Pradesh. Concurrently, clearance for businesses: (i) the Expert skills development has been put on center stage Appraisal Committee, the statutory body that by consolidating the different agencies and recommends environment clearance, has been ministries dealing with the subject under the new barred from seeking additional environmental Ministry of Skills Development, impact studies in the final (second) stage of the Entrepreneurship, Youth Affairs and Sports. clearance procedure; and (ii) acquisition of land is no longer a necessary condition for initiating Regulatory compliance costs have come environmental clearance, proof of land down. The Department of Industrial Policy and acquisition proceedings will suffice. Promotion implemented new measures to ease the burden of regulatory compliance for As many as 75 million poor households could businesses. The steps, listed in an advisory to all gain access to bank accounts. Over 60 percent ministries, include a requirement for prior of India’s population is unbanked and a approval from department heads before staggering 90 percent of small businesses have inspecting any factories or business premises, no linkages with formal financial institutions. shift to a system of self-certification of The recently launched Pradhan Mantri Jan adherence to official norms by all companies, Dhan Yojana (PMJDY) or the people’s wealth and maintenance of a single electronic register program, seeks to address these challenges by by all businesses. opening bank accounts for 75 million poor rural and urban families by January 2015, in public or Land acquisition procedures could become private banks. All such accounts will be linked easier. To simplify the process of land to a domestic debit card network, RuPay. The acquisition, the Ministry of Rural Development program is also expected to offer an accident proposed 19 amendments to the 2013 Land insurance cover of up to INR0.1 million ($1650) Acquisition, Rehabilitation and Resettlement and a INR5,000 ($83) overdraft facility once the (LARR) Act. These include (i) re-examination account has been active for six months and has of the requirement of prior consent of 70 percent been linked to Aadhaar identity number. A and 80 percent of the affected families for financial literacy component is also integral to public-private partnerships (PPPs) and private PMJDY. The program envisages covering aspects of micro insurance and pension schemes 21 during its second phase, which will begin in The Apprentices (Amendment) Bill, 2014 was 2015 and end in 2018. The RBI is expected to approved by the parliament in August. 13 India Development Update October 2014 play the role of a key enabler and partner the A proposed new holding structure for public government in the financial inclusion drive. sector banks could improve their Earlier this year, RBI had released guidelines for performance. To address some of the main small and payment banks which will only accept challenges in the banking sector, the May 2014 deposits and handle remittances, services which Report on Governance of Boards of Banks in are key to migrant workers, low income India has made key proposals to level the households, and small businesses. playing field between public and private sector banks, empower bank boards, and separate Defense and railways have become more open ownership and management functions.22 The to FDI. Following the proposals made in the suggested holding company structure through Union Budget 2014-15, the Cabinet raised the Bank Investment Companies (BIC) for public FDI limit in defense manufacturing to 49 percent sector banks will allow the BIC to perform a and fully opened up the railway infrastructure principal shareholder function while managing segment—including high-speed trains, signaling the risks of moral hazard, a feature that currently systems, electrification, manufacturing and works against the efficient functioning of public maintenance of rolling stock—to foreign sector banks. investment. Financial regulations have been strengthened to increase transparency and deepen financial 2. Global developments markets. The Parliament approved the Securities Law (Amendment) Bill, 2014 aimed Global growth has been weaker than at empowering the Securities and Exchange expected in the first half of this year. U.S. Board of India (SEBI), the financial market growth has been gathering momentum while the regulator, by expanding its jurisdiction over Euro Area and Japan appear to be stagnating. Collective Investment Schemes. This will allow Supported by rising employment and investment the SEBI to call for documents, attach assets, growth, a still accommodative monetary policy, detain entities under probe, and establish special and easing fiscal stance, U.S. growth recovered courts to expedite cases. Mindful of pressures on strongly in Q2 2014 (4.6 percent saar) from a the profitability of public sector banks and their sharp contraction in Q1 (-2.1 percent saar). need to raise INR 4–4.3 trillion of Tier I Capital Meanwhile, in the Euro Area, especially in its between FY2015-19 to fund growth and meet core, growth has been markedly weaker than Basel III norms, the RBI has recently permitted anticipated so far this year. Euro Area GDP was banks to issue Additional Tier I (ATI) flat in Q2, following a small uptick in Q1, with instruments to retail investors. These the recovery momentum still impaired by weak instruments can potentially widen the investor domestic demand. In Japan, a sales tax hike in base and increase investor appetite for April caused volatility in quarterly activity: instruments with specific loss absorption growth surged to 6.0 percent in Q1 reflecting a features. The principal loss absorption would be front-loading of demand, but shrank by 7.1 through conversion into common shares or a percent in Q1 as consumers retrenched. Among write-down mechanism (temporary or developing countries, growth in China slowed in permanent). The RBI has also allowed banks to Q1 as the authorities made efforts to rein in pay coupons on debt instruments from their credit growth but renewed policy stimulus distributable revenue reserves under specific boosted growth in Q2. circumstances, should current year profits be insufficient. In addition, the RBI raised the FII sub-limit in government bonds by US$ 5 billion after the existing US$ 20 billion limit was almost exhausted, in an attempt to stabilize yields on government securities. 22 P J Nayak Committee Report to Review Governance of Boards of Banks in India, May 2014. 14 India Development Update October 2014 countries with strong trading ties to the United States where import demand has improved in line with the economic recovery. In turn, industrial activity in these regions has benefitted from the stronger exports. In contrast, exports from developing Europe and Central Asia contracted in Q2 due to weakness in the Euro Area and trade restrictions associated with rising geo-political tensions surrounding Ukraine. With varied growth prospects, monetary policy challenges are also diverging in high income countries. Markets increasingly expect the U.S. Federal Reserve’s asset purchase programs to come to an end by October 2014, new guidance on monetary policy to be issued in Q4, and the first policy rate increase to occur by mid-2015. In Europe, in contrast, inflation and inflation expectations continue to trend lower. The European Central Bank (ECB) introduced a series of loosening measures in June and Global interest rates remain exceptionally September, including lower interest rates and the low. Notwithstanding a weak start to the year, launch of targeted refinancing operations and global equity markets have risen to all-time asset purchase programs. With these measures, highs in recent months, and government bond the ECB plans to increase its balance sheet back yields have fallen to record lows. Benchmark to its level in 2012, an increase of about stock indices in the United States and the United EUR800 billion. In Japan, inflation expectations Kingdom, in particular, have risen to fresh highs are weakly anchored and loose monetary policy on the back of strengthening macro data, still is projected to continue with the central bank accommodative U.S. monetary policy, and implementing its quantitative easing as expected credit easing by the ECB. The ECB’s scheduled. recently announced policy measures have led to a weakening of the euro against the dollar, which generated capital flows into U.S. long- term bond markets but also search-for-yield flows into riskier assets such as emerging market stock markets including India. As a result, capital flows to developing countries, which had weakened in early 2014 in a market sell-off, have resumed strongly since March and are 14 percent above 2013 levels. On a year-to-date basis, flows to South Asia (primarily India) are up by 37 percent compared to 2013, mainly reflecting strong portfolio flows (notably bonds). Global trade has recovered in recent months but remains on a weak post-crisis trend. Exports are growing strongly in East Asia, South Asia, and Latin America, particularly in 15 India Development Update October 2014 market conditions should provide some momentum ahead, but investment prospects remain subdued and precautionary savings are still high. Exports should gradually improve, supported by strengthening demand from the United States and a weakening euro. In Japan, monetary policy accommodation and reform commitments will provide ongoing support, but fiscal consolidation is expected to keep domestic demand subdued throughout 2015, with exports only recovering slowly. The pace of recovery varies substantially across major emerging economies. Overall, PMI data point to further, albeit moderate, expansion in developing countries in Q3 as growth recovers from a weak start to 2014 across many emerging economies. However, performance continues to disappoint in Latin America, Russia, and South Africa. In China, stimulus measures and rising external demand are expected to deliver the authorities’ growth target of 7.5 percent for the year. In Mexico, growth is picking up, with a reform-minded government boosting investors’ sentiment. In contrast, Brazil is currently in recession, with growing fiscal imbalances and above-target inflation accentuating a loss of business and Developing countries’ growth is expected to consumer confidence, while a deepening crisis is rise modestly but remain below the pre-global contributing to weakness in Argentina. In crisis pace in most regions. While the trade Russia, the impact of geopolitical tensions has intensity of global growth is projected to remain been tempered by still high oil prices but growth below pre-crisis norms, a gradual recovery in is weakening and sanctions are keeping both high-income countries should provide some inflation and borrowing costs high. In South impetus, particularly for export-oriented Africa, growth has been held back by mining economies with links to U.S. markets. Financial strikes so far this year and the current account conditions are expected to remain benign as the deficit has widened again. continued accommodative monetary stance of the ECB could help counteract the global impact 3. Outlook of an eventual monetary tightening in the U.S. Key commodity prices, including oil, are Global conditions are improving, with growth expected to remain stable or decline marginally. in high income countries expected to pick up modestly in the second half of 2014. In the Growth in India is expected to improve to 5.6 United States, the recovery is supported by percent in FY2015. Following the improvement strengthening domestic demand as better in Q1 FY2015, economic recovery is expected employment prospects support real income to take firmer hold during the rest of the year. growth and confidence, while investment is Continued strengthening of the U.S. economy projected to rise in line with strong profits and will support demand for India’s merchandise still favorable financing conditions. In the Euro and services exports, while remittances from Area, a slow improvement in credit and labor Indians working abroad will raise incomes and 16 India Development Update October 2014 stimulate domestic demand. Consumers and currently estimated 6-7 percent range.23 Under firms alike will also benefit from declining oil these conditions, GDP growth is expected to rise prices, which are expected to dip below US$100 to 6.4 percent in FY2016 and accelerate further per barrel in calendar 2015. The authorities’ to 7.0 percent in FY2017. continued efforts to unblock investment projects, stimulate infrastructure investment and FDI, and The current account deficit is expected to foster a supportive policy environment are likely widen somewhat, but remain well below the to contribute to investment returning to above 30 average of the last few years. The current percent of GDP, after dipping below this level in account deficit is expected to widen from 1.7 FY2014. Improving investment, positive percent of GDP in FY2015 to 2.0 percent of business sentiment, and strong export demand GDP in FY2015 as import demand rises with amplified by a competitive exchange rate are accelerating growth. While the maintenance of expected to lift manufacturing growth well into policy barriers to gold imports is likely to keep positive territory after last year’s contraction. this import category compressed in the near Services are also expected to continue term, imports of capital goods and intermediate performing well, while agricultural growth is inputs are likely to rise to accommodate higher unlikely to exceed last year’s outturn of 4.7 investment and growing exports and domestic percent due to the unfavorable base effect and demand. As growth continues to accelerate in deficient and untimely monsoon rains. the medium term, the current account deficit is expect to widen further to 2.4-2.5 percent of GDP; this would still place the deficit well below the 3.2 percent average of the last five years and the 4.7 percent high in FY2013. Inflation is expected to moderate substantially in FY2015 before rebounding somewhat in the medium term. The downward momentum in core prices of the last few months and the widening of the output gap are expected to keep core inflation muted in FY2015. Growth in fuel prices is likely to decelerate as global oil prices decline and domestic prices reach parity with international levels sometime this fall. Growth in food prices may accelerate due to the expected moderation in growth of agricultural output, but the increase will be moderated by Growth is expected to strengthen further over policy decisions to keep minimum support the medium term. Due to favorable prices for rice and pulses close to last year’s demographics, relatively high savings, and levels and raise minimum export prices for continued efforts at improving education and onions. Overall, average WPI inflation is skills, India’s long-run growth potential remains expected to decline to 4.3 percent in FY2015 high. The slowdown of the last few years has before rebounding to slightly above 5 percent in opened a negative output gap which would take the medium term as demand is expected to several years to close even at growth rates well strengthen. Inflation could come down further if above the baseline scenario of this Update. the RBI adopts the inflation targeting Furthermore, the authorities reform efforts to recommendations of the Patel Committee, unify India into a common market (GST), improve firms’ competitiveness (labor), strengthen fiscal balances, and support 23 Potential growth calculated by (i) smoothing of investment could raise potential well above the annual and quarterly GDP series, and (ii) production function approach (see Global Economic Prospects 2014 for the latter estimates). 17 India Development Update October 2014 including a switch to the CPI as the nominal continued commitment to fiscal discipline are anchor and bringing inflation down to a 4 expected to offset any potential adverse effects percent (+/- 2 percent) band over the medium on debt sustainability. On the other hand, risks term. to the primary balance or growth could have negative implications for the debt-to-GDP The general government deficit is expected to trajectory: if economic growth were to fall decline further to 6.1 percent of GDP in below the baseline projections in each of FY2015. The reiteration of a commitment to forecasting years by one standard deviation of fiscal consolidation in the new Government’s the historical distribution, the government’s maiden budget, combined with a pick-up in the debt-to-GDP ratio could instead rise to 72 pace of economic activity and recently percent of GDP by FY2017. announced sales of major stakes in public sector enterprises, is expected to bring the general Decomposition of General Government Debt government deficit down from 6.8 percent of (percent) 2014/15f 2015/16f 2016/17f Debt-GDP Ratio (baseline) 66.7% 65.4% 63.3% GDP in FY2014 to 6.1 percent in FY2015. Change in Public Debt 0.3% -1.3% -2.1% Expenditure restraint will also be aided by lower Identified flows 0.2% -1.3% -2.1% spending on fuel subsidies on account of Real Interest Rate 1.0% 0.8% 0.8% declining global oil prices and the recent Primary Balance 2.7% 1.9% 1.4% deregulation of retail diesel. Over the medium Real GDP Growth -3.5% -4.0% -4.3% Residual 0.1% 0.0% 0.0% term, the general government deficit is expected Effects of shocks on debt-GDP ratio to decline to 5.0 percent of GDP by FY2017 as Fall in Real GDP growth 69.6% 71.2% 71.9% the quality of public spending improves through Fall in Inflation rate 69.0% 69.9% 69.9% the work of the Expenditure Management Rise in Interest Rates 67.1% 66.2% 64.4% Commission, with productive public investment Rise in Primary B alance 68.2% 68.3% 67.6% Normally distributed shocks (drawn from history FY2004-FY2014) were introduced to taking the place of fuel, fertilizer, and food real GDP growth, inflation rate and interest rate. subsidies. Revenues could get a substantial boost One standard deviation negative shock to the primary balance (taking the reference period as FY2004-2014). if the federal and state authorities reach agreement on the implementation of the Goods Globally, risks are primarily on the downside. and Services Tax (GST) which will stimulate As a group, developing countries remain economic activity and improve the efficiency of vulnerable to bouts of financial market revenue collection (see the following section for disruptions as a result of changes in monetary a detailed discussion of the GST). policy in high-income countries or weakening investor sentiment if geopolitical tensions (e.g., Government debt is likely to remain on a in Eastern Europe and the Middle East) or health sustainable trajectory. Most of the decline in concerns (e.g., from the Ebola virus in West the debt-to-GDP ratio over the past decade can Africa) escalate. The U.S. Federal Reserve is be attributed to a favorable macroeconomic projected to start raising policy rates in mid- environment and particularly rapid GDP growth. 2015, which carries the risk of renewed bouts of Under this Update’s baseline growth, inflation, financial market volatility, although this could and fiscal deficit projections, the debt-to-GDP be offset to some extent by recently announced ratio is likely to rise marginally from 66.4 ECB easing measures. Investor sentiment could percent of GDP in FY2014 to 66.7 percent in also suffer if a rapid unwinding of Chinese debt FY2015. Thereafter, under the assumption that leads to sharp deleveraging. growth accelerates, the central government continues its fiscal consolidation efforts, and Domestic risks could be offset, to a large state governments remain on the adjustment path extent, by continued progress on the reform recommended by the Thirteenth Finance agenda. The baseline outlook in this Update is Commission, the debt-to-GDP ratio is expected predicated on a recovery in investment, a strong to resume its earlier downward trend and fall to pick-up in manufacturing growth, and continued 63.3 percent of GDP in FY2017. Even if real progress on fiscal consolidation. Even in a interest rates rise, a recovery in growth and favorable external environment, these outcomes 18 India Development Update October 2014 could be at risk from several domestic factors. between 2011 and 2020) is estimated at US$1.1- Uncertainty around the allocation of coal blocks 1.7 trillion.24 These estimates, however, refer could push up coal imports and jeopardize primarily to “hard” infrastructure like transport, energy supply—a major concern since electricity electricity, water and sanitation, waste is consistently ranked as a top-three constraint management, telecommunications, and for manufacturing firms in India. Findings of the irrigation. While the constraints arising from Seventh Central Pay Commission, the limited quantum and quality of “hard” supply composition of which was approved by the chain infrastructure are well recognized, those Cabinet in February, could push up the wage that derive from limiting “soft” infrastructure expenditure once its recommendations are made factors are less well researched. “Soft” available within the next 12 months. The report infrastructure primarily encompasses aspects of will guide the new structure of the salaries and governance as well as economic and social pensions of more than 800,000 central infrastructure and is vital to the delivery of government employees and retirees; the previous services which ride on the “hard” Pay Commission recommendations were infrastructure.25 implemented in FY08/09 (retroactive to January 1, 2006) and pushed up expenditure by 0.5 percent of GDP in that year. However, these risks could be more than offset by the potential of key reform actions (e.g., the GST, labor and regulatory reforms, energy reform, new monetary policy framework, financial inclusion) to remove many of the major binding constraints to growth in India. 4. Supply Chain Delays and Uncertainty Improving manufacturing performance in India is a necessary condition for high growth and job creation. The manufacturing sector in India accounts for around 16 percent of GDP, a Costs of logistics, a key component of soft infrastructure, are relatively high in India. A level that has remained largely unchanged in the recent survey of about 70 textiles, electronics, last two decades. This is quite low relative to auto components, and heavy-engineering many comparator countries (e.g., Brazil, China, companies in India reveals that manufacturing Indonesia, Korea, and Malaysia), even after firms incur relatively higher costs in logistics controlling for differences in per capita incomes. vis-à-vis the “usual suspects” like power and The under-performance of the manufacturing labor. The cost of logistics ranges from over 10 sector in India over the last two years was a percent of net sales for auto components to over major factor in the overall growth slowdown; 14 percent for electronics.26 These costs put conversely, resumption in manufacturing growth will be necessary for India to return to high growth rates observed during the late 2000s and 24 realize the full potential of the demographic Andres, L., D. Biller, and M. Herrera-Dappe (2013). dividend. Boosting manufacturing performance “Infrastructure Gap in South Asia: Infrastructure Needs, Prioritization, and Financing.” Washington, DC: World is therefore a policy priority. Bank. 25 Economic infrastructure includes financial system and Manufacturing performance depends payment systems, financial regulations and monetary critically on infrastructure, where India’s policy, accounting standards, etc., while social needs are massive. India’s infrastructure gap infrastructure includes educational and research systems. 26 (i.e., infrastructure investment requirements Auto components logistics costs could well be higher, were it not for buyer requirements of proximate location 19 India Development Update October 2014 Indian manufacturing firms in a position of challenges and the market structure and major competitive disadvantage versus Indian organization of the trucking sector.30 companies in the service sector and competitors abroad, where the best-practice benchmarks for logistics costs are around 3 percent of net sales for auto components and around 4 percent for consumer durables.27 High logistics costs put manufacturing firms at a disadvantage (costs as percent of net sales) Compensation Power, fuel, Logistics of employees and water Auto components 7.1 3.7 10.4 Textiles 6.2 6.8 13.3 Electronics 11.8 1.8 14.1 Heavy Engineering 8.6 1.1 12.2 Hotels & tourism 24.6 6.9 0.9 Telecom 14.3 8.8 0.4 Source: Prowess. Most transportation in India is by truck, but “hard” road infrastructure is just one of many constraints for shipping goods. Road Regulatory impediments increase truck travel traffic accounts for about 60 percent of all time by a quarter. Besides road quality, the freight traffic in India.28 Yet, the average speed next most frequently cited causes for freight of a truck on a highway is reported to be just 20- delays are customs inefficiencies and state 40 km/hour and trucks travel on average 250- border check-post clearances. A number of 300 km per day (compared to 450 km in Brazil studies in the last few years have found that for and 800 km in the United States). Road up to 60 percent of journey time, the truck is not conditions play a role in the slow pace of moving.31 Approximately 15-20 percent of the movement of goods, as does the generally poor total journey time is made up of rest and meals; condition of vehicles. Over one-third of trucks in another around 15 percent at toll plazas; and the India are more than 10 years old; as a rule of balance, roughly a quarter of the journey time, is thumb, a vehicle which is less than six years old spent at check posts, state borders, city can make about 8,000 km per month while a entrances, and other regulatory stoppages.32 vehicle which is more than 10 years old can make only about 2,000-4,000 km per month.29 However, in India, as in developing most 30 countries, high logistics costs mainly depend Jean-François Arvis, Gaël Raballand, and Jean-François Marteau, The Cost of Being Landlocked: Logistics Costs upon regulatory and policy implementation and Supply Chain Reliability (Washington, DC: The World Bank, 2010). 31 “The percentage of actual moving time to the total trip time was about 69%, 54% and 38% for Mumbai-Delhi, Delhi-Kolkata and Kolkata-Chennai routes respectively,” according to the survey by Rajiv Ghandhi Institute for (see the example of Maruti Suzuki in the discussion that Contemporary Studies, cited in: Ministry of Road Transport follows). and Highways, Government of India, “Report of the Sub - 27 Skill gaps in the Indian Logistics Sector- A white paper - group on Policy Issues,” September 2011, p. 33. Another September 2007, KPMG India study suggested that out of total trip time, actual moving 28 Government of India, Ministry of Road Transport and times accounted for only 33% for trips of less than 500km, Highways, Annual Report 2011-12. 36% for 500-999km trips, and 43% for longer distances. 29 The relatively high age of truck fleet in India is related to JPS Associates, “Study on Economics of Trucking the inability of small scale, unorganized and fragmented Industry,” p. E-VIII. 32 truckers, which account more than two-thirds of the Ibid., p. 82; JPS Associates, “Study on Economic Cost of industry, to replace vehicles in time. Inter-State Barriers in Goods Traffic.” 20 India Development Update October 2014 Over 650 checkpoints slow freight traffic at and not using the high-quality and nearby state borders. The checkpoints are tasked Cochin port just to avoid the Tamil Nadu-Kerala primarily with reconciliation of central versus border crossing.35 An illustrative comparison of state sales taxes in one state with those in the logistics costs of three SMEs manufacturing other, as well as checking for road permits and high-value, low-volume items (alcohol products, associated road tax compliance, collecting and high-end batteries, and transformers) reveals that checking for other local taxes, clearances, as the firm whose suppliers were almost fully based well as checks for and imposition of taxes on or within the same state had logistics costs of 4.4 prohibition of the movement of specific types of percent of sales vs. 6 percent for a firm with one goods, such as alcoholic products (for state major supplier from out-of-state and 9.2 percent excise taxes) and mineral products (for for a firm with multiple suppliers from other royalties).33 In the auto industry, the absence of states. any uniform specification for car carriers means different interpretations by different Regional Transport Offices (RTOs), with each state imposing different rules.34 For example, the state of Uttar Pradesh requires trucks that pass through the state (i.e., not for delivering goods within the state but using the state roads to transit through to their destination) to declare their planned route. Reportedly, truck drivers frequently change their routes for practical reasons, such as to avoid traffic jams or congestion on the declared route. However, the fear of penalty levied for deviating from the declared route encourages truck drivers to speed with potential adverse consequences for road safety. The regulatory difficulties in crossing state borders have as much of an impact on freight Unpredictable variations in shipment times performance as the quality of long-distance affect firms just as much as lengthy transit. roads. The difficulties at checkpoints can Except for the very few large trucking substantially impact freight routes: for example, companies, which typically have established exporters from manufacturing hubs like Tirupur (mostly informal) links to regulatory authorities and Coimbatore in Tamil Nadu report diverting across their routes, most trucking companies their shipments by several hundred kilometers cannot predict how long their trucks will be stopped en-route. This has a cascading effect on 33 The commercial, excise and VAT checkpoints tend to transport time, when the unpredictability of absorb the most time in delays according to a 2003 study by Arindam Das-Gupta, “Internal Trade Barriers in India: arrival times at city entrances hinders effective Fiscal Check-posts,” paper, August 2003. A more recent planning and adds further delays since all major study suggests that “VAT/Commercial check-posts are the cities have entry restrictions in place for goods most common on-road check-posts and involve the most vehicles. In turn, stretched lead times cause cumbersome and costly procedures than other check-posts lower asset utilization (fewer trips possible in a barriers,” JPS 2011, “Inter-State Barriers,” p. 10. However, this same study shows that RTO check posts are more given time) and higher in-transit inventories. prevalent, and that check post halting time is primarily Uncertainty in lead times results in the need to accounted for by RTO posts. At the same time, the incidence of defaults is much higher for commercial tax 35 and VAT, resulting in substantial additional hours of delay. Koi Yu Adolf Ng and Girish C. Gujar, "The spatial 34 “Methodology for measuring the logistics cost for major characteristics of inland transport hubs: evidences from manufacturing exports and assessing its impact on their Southern India," Journal of Transport Geography 17 competitiveness”, FICCI, 2011 (2009): 346–356. 21 India Development Update October 2014 keep higher levels of “buffer” inventory, safety involved in transportation of perishable stock, or lost sales. A survey of around 70 firms products, of which dairy (wet milk) constitutes in four industries revealed that, on average, about 80 percent. This leaves only about 7,000 firms maintain 43 days of inventory, of which refrigerated vehicles for all other perishable approximately 27 percent (11.6 days) is buffer categories put together, a number that is stock. Worse, because firms cannot accurately miniscule by several estimates.38 plan deliveries, they may incur foregone sales penalties for non-delivery. A detailed study on Some industries have adopted rather extreme three selected survey participants indicated that coping strategies. In the automotive industry, lost sales and additional buffer stocks to account the physical distribution of activities and the for delays and uncertainties can account for at reaping of scale and other economies have been least 14 percent, and as much as 23 percent, of almost entirely subordinated to overcoming the total logistics costs.36 logistical difficulties. Here, the case of Maruti Suzuki is illustrative. In the early 2000s, the Industries that depend critically on prompt company relied on some 400 major suppliers shipping are adversely affected both in terms located across India, with some almost 2,500km of costs and opportunities to grow business. distant from its main plant in Haryana, and its The costs of delays and lost sales are not easily total logistics costs were well above its wage bill quantifiable, although willingness to pay for (perhaps up to four times as high).39 At the time, alternate transport options is indicative. It is not it had to carry large buffer stocks and deal with rare for suppliers to pay hefty premiums for substantial freight costs. In 2013, those costs shifting to a faster, more expensive, mode of were slashed by requiring almost all suppliers to transportation.37 More than half of the firms build, warehouse or locate within a few hours surveyed stated that they used premium freight radius of the plant. Approximately 80 percent of providers for high priority orders, with the Maruti Suzuki’s suppliers are currently located highest proportion (82 percent) among within a 100km radius of the plant. The electronics firms. Roughly 45 percent of firms company reports that its buffer stocks are now also indicated a willingness to pay a premium down to zero, and it is running lean production for on-time delivery including margin businesses processes. Maruti Suzuki has been able to drive like textiles and apparel. For industries that rely this change because of the enormous scale of its on refrigerated trucks, the impact of delays on operations, which make its business alone the road is magnified manifold given that the valuable enough to its suppliers to motivate refrigeration unit cannot be switched off even them to relocate. when the truck is waiting at a check post. Such issues have prevented the refrigerated India’s logistics challenges extend beyond transportation fleet from growing to required road transport to port performance and numbers. There are about 25,000 reefer vehicles intermodal integration. Despite a very creditable record of achievement in increasing 36 Annex A, p. 34. 37 Arvis et al., The Cost of Being Landlocked, p. 33. A 38 detailed study in Vietnam reveals that “the root cause for Ernst & Young – NCCD India joint report “Refrigerated costly logistics is the incidence of unpredictability that Transportation: bottlenecks and solutions”, March 2013 permeates supply chains. This unpredictability requires Another regulatory peculiarity that limits development of manufacturers to self-insure against uncertain freight this important sector is that while exemption from excise itineraries by carrying higher levels of inventory than they duty is available for completed reefer trucks, it is not for would otherwise need to manage their daily operations, or individual components. Since reefer trucks are assembled face the even costlier risk of lost sales, interrupted according to specific requirements and are not sold off the manufacturing production runs, or a proliferation of pricey, shelf, it is procedurally challenging to apply these excise avoidable emergency shipments.” World Bank, “Taming duty benefits. Taking advantage of these intended benefits Unpredictability as Source of Growth: What More thus leads to unavoidable and unintended cost escalation. 39 Competitive Freight Logistics Can Do in Vietnam,” Sumila Gulyani, “Effects of Poor Transportation on Lean summary note, 2014, p. 2; and Luis C. Blancas et al., Production and Industrial Clustering: Evidence from the Efficient Logistics: A Key to Vietnam’s Competitiveness Indian Auto Industry,” World Development 29, no. 7 (Washington, DC: The World Bank, 2014). (2001), pp. 1157-1177. 22 India Development Update October 2014 both volume and performance over the last The transformational impact of the GST twenty years, India’s ports face many challenges could be enhanced by a systematic to their ability to meet future demand and dismantling of inter-state check-posts. This competition from larger and more efficient ports would necessarily be a complex task given the in the region. These include: (i) ability to handle multiple stakeholders involved and the perceived the largest vessels; (ii) transport infrastructure and potentially real revenue implications for linkages to ports; (iii) private sector state governments. The process of participation; (iv) port governance structures; implementation requires not only the resolution and (v) the legal and regulatory framework in of a number of issues on fiscal transfers and which ports operate. In particular, India’s 12 compensation between the central government major and 187 non-major ports operate within and the states, but also putting in place different institutional and regulatory sophisticated systems to efficiently handle frameworks, and all ports have been slow to transactions. To enable resolution of these embrace modernization of management complex issues, the purview of the ongoing structures. Meanwhile, intermodal transport is a consultative process for the GST roll-out among new phenomenon in India with no underlying the states and between them and the central policy framework. For the first time inland water government could potentially be expanded to way authority, railways and national highways address other issues that cause stoppages and are beginning to talk about intermodal facilities, delays for trucks at check-posts, over and above transshipment & handling yards and inland tax collection and compliance requirements. container depots linked to various modes. Many of these can be addressed even in advance However, there is no policy framework to guide of the GST, and could be the object of these discussions and to engage with businesses, continuing reform even once it is in place. state governments and other stakeholders. Replicating the example of Haryana, which has entirely shifted to a mobile squad based system Implementation of the GST is the most of monitoring and enforcement, could be crucial reform that could address today’s considered by other states. Another promising logistics challenges. The GST offers a unique reform that has already been undertaken by opportunity to rationalize and re-engineer some states and may be considered for logistics networks in India, given the inherent replication in others is the introduction of ‘e- inefficiencies with taxes based on the crossing of road permits’. These allow firms to print out administrative boundaries. Under the GST, the permits in advance for their shipments, which variety of different and cascading taxes, many of allows for rapid clearing of state border and them locally administered, will be replaced by a other check-posts. Finally, a roll-out of e-tolling unified taxation system. This will abolish the on national highways and its extension to all need for reconciliation of taxes when crossing state highways to eliminate waiting at tolls could state borders, eliminate the cascading effect of further help improve logistics performance. the Central Sales Tax (CST), and ensure that inter-state and intra-state transactions incur the Improved governance structures could also same tax liability by allowing firms to claim full strengthen port performance and enable credit on input purchases. The GST will free up intermodal integration. For ports, sectoral decisions on warehousing and distribution from governance reforms could encourage tax considerations so that operational and competition between ports and, where volume logistics efficiency determines the location and and layout permit, between terminals within movement of goods. Freight and logistics ports. This could help create a level playing field networks will realign according to the location for major and non-major ports, under the of production and consumption activities. This purview of an independent Indian Ports will create the hub-and-spoke models that are regulatory body to promote and protect fair needed to improve freight and logistics competition. Port administration could be performance. corporatized within a legal framework and corporate charters that establish a clear 23 India Development Update October 2014 commercial orientation while recognizing public interest responsibilities. Port corporations could progressively move towards the Landlord Model, adapted to their own circumstances and port development plans, but encouraging private sector investment and participation in the port’s terminal activities by lease and/or concession. With regard to intermodal transport, a comprehensive intermodal surface transport policy which creates a platform for efficient and reliable freight and logistics services could be the missing link in linking investments in freight corridors, increased private sector involvement in ports, and revitalization of inland waterways. The potential gains of more efficient and reliable supply chains are enormous. Simply halving the delays due to road blocks, tolls and other stoppages could cut freight times by some 20-30 percent, and logistics costs by even more, as much as 30-40 percent. This would be tantamount to a gain in competitiveness of some 3-4 percent of net sales for key manufacturing sectors, helping India return to a path of high growth and enabling large-scale job creation. 24 India Development Update October 2014 India: Selected Economic Indicators 2009/10 2010/11 2011/12 2012/13 2013/14 2014/15 2015/16 2016/17 Est. Proj. Proj. Proj. Real Income and Prices (% change) Real GDP (at factor cost) 8.6 8.9 6.7 4.5 4.7 5.6 6.4 7.0 Agriculture 0.8 8.6 5.0 1.4 4.7 2.5 3.0 3.0 Industry 9.2 7.6 7.8 1.0 0.4 5.0 5.5 5.9 Of which : Manufacturing 11.3 8.9 7.4 1.1 -0.7 4.0 4.5 5.2 Services 10.5 9.7 6.6 7.0 6.8 6.6 7.5 8.3 Real GDP (at market prices) 8.5 10.3 6.6 4.7 5.0 5.6 6.4 7.0 Prices (average) Wholesale Price Index 3.8 9.6 8.9 7.4 6.0 4.3 5.4 5.3 Consumer Price Index 12.4 10.4 8.4 10.4 9.7 … … … GDP Deflator 6.1 9.0 8.5 7.2 6.9 4.3 5.4 5.3 Consumption, Investment and Savings (% of GDP) Consumption 1/ 70.7 70.0 73.6 74.6 73.6 72.6 72.3 71.2 Public 11.9 11.4 11.4 11.8 11.8 11.9 11.5 11.5 Private 58.8 58.5 62.2 62.8 61.8 60.7 60.8 59.7 Investment 2/ 31.7 30.9 31.8 30.4 28.4 29.6 30.2 31.4 External Sector Total Exports (% change in current US) -5.8 37.5 17.9 0.3 3.9 7.0 11.2 13.5 Goods -3.6 37.5 23.6 -1.1 3.9 8.5 12.9 14.7 Services -9.7 37.5 7.1 3.4 4.0 4.0 7.8 10.9 Total Imports (% change in current US) -0.1 28.8 24.2 1.1 -6.6 7.9 11.8 13.8 Goods -2.6 26.7 31.1 0.5 -7.2 8.9 12.2 13.7 Services 14.4 39.4 -7.3 5.0 -2.8 1.6 9.3 14.3 Current Account Balance (% of GDP) -2.8 -2.7 -4.2 -4.7 -1.7 -2.0 -2.4 -2.5 Foreign Investment (US billion) 47.0 37.6 38.6 46.5 26.4 47.0 45.0 45.0 Direct Investment, net 18.0 9.4 22.1 19.8 21.6 22.0 25.0 25.0 Portfolio Investment, net 29.1 28.2 16.6 26.7 4.8 25.0 20.0 20.0 Foreign Exchange Reserves (US billion) 3/ 254.7 274.3 260.1 259.7 276.4 321.1 328.6 342.6 General Government Finances (% of GDP) Revenue 4/ 18.6 20.2 18.6 19.5 19.9 20.0 20.8 22.0 Expenditure 28.0 27.1 26.2 26.6 26.6 26.1 26.5 27.0 Deficit 9.4 6.9 7.6 7.1 6.8 6.1 5.7 5.0 Total Debt 5/ 72.5 67.4 67.0 66.9 66.4 66.7 65.4 63.3 Notes: 1/ Consumption is equal to final consumption expenditure plus valuables. History includes national accounts' discrepancies. 2/ Gross fixed capital formation 3/ Excluding gold, SDR and IMF reserve position 4/ Includes receipts from 3G spectrum auctions and disinvestment Sources: Central Statistics Office, Reserve Bank of India, and World Bank Staff Estimates. 25