Issues and priorities

1.55  The last Survey had pointed out the need for nurturing the investment climate to consolidate the growth process. There are some encouraging signs of positive developments on both fronts. 

1.56  First, there is a pick up in investment.  Gross domestic capital formation as a proportion of GDP, that is, the investment rate, has increased by 3.7 percentage points since 2001-02 to reach 26.3 per cent in 2003-04, the highest since 1996-97. There is increased activity in the primary market for securities, with the overall volume of issuance going up by more than five times in calendar 2004. The stock market indices peaked at an all-time high in mid-February 2005. 

1.57  Second, the growth performance of the Indian economy during 2003-04 and 2004-05 indicates a possible ratcheting up of the trend rate of growth of the economy, from around 6 per cent, to about 7 per cent per year (Figure 1.3). Developments in the current year provide supportive evidence. The current account of the balance of payments has turned into a deficit showing an excess of investment over savings. Growth appears to have surpassed all projections made at the beginning and early part of the year. There was an initial spurt of inflation of the ‘imported’ variety, exacerbated by inflationary expectations induced by a deficient southwest monsoon. The deceleration of the inflation rate points to the strength of flexible supply response from a wide variety of the productive sectors. While a business-cycle type explanation of the performance of the economy in the two years 2003-04 and 2004-05 is also tenable, a trend acceleration may be underway with the recently observed sustained double-digit year-on-year growth rates of capital goods (except in October 2003 and in November 2004) and consumer durables (except in May 2004) since September 2003, as well as increase in the savings and investment rates.

1.58  Yet, vigorous efforts are needed to accelerate growth to achieve the NCMP mandate of ensuring “that the economy grows at least 7-8 per cent per year in a sustained manner over a decade and more and in a manner that generates employment so that each family is assured of a safe and viable livelihood.”  In its “Approach to the Mid-term Appraisal of the Tenth Plan”, the Planning Commission has pointed out that a growth above 10 per cent in industry is essential to realize the NCMP growth objective.  It is doubtful that the targeted high growth can be achieved with the current levels of investment simply by reducing the incremental-capital output ratio. Even after its increase in the last two years, the investment rate continues to be not only far below that in China and East Asia but also lower than that assumed in the Tenth Plan. 

1.59  Demographic dynamics, with an increase in the share of working age population in total population and increasing incomes, have had a positive impact on the savings rate.  This virtuous trend is likely to continue for some more years. Simultaneously, a part of the recent improvement in the savings rate has come from a decline in public dissaving. The FRBM Act has focused attention on improving public finances, and reducing not only the preemption of investible resources by the Government but also revenue expenditure to open up fiscal space for augmented capital expenditure.  With the notification of the FRBM rules, the planned reduction in the revenue deficit of the Centre will help in directly augmenting saving and investment. Further enhanced credibility of the fiscal stance will yield upfront indirect benefits on the interest rate and hence investment front. The Twelfth Finance Commission has recommended that each State should enact a fiscal responsibility legislation providing for elimination of revenue deficit by 2008-09 and reducing fiscal deficit to 3 per cent of State Domestic Product. This recommendation, together with the Commission’s linking of Central debt relief to States with fiscal reforms, should be effectively utilized by both the Centre and the States to pursue fiscal consolidation at the State level.

1.60  One of the challenges in fiscal reform will be reconciling the need for fiscal consolidation with appropriate tax reform. Indirect taxes not only affect efficiency of resource allocation but also the investment climate. Since a major share of tax revenue of the Central and State Governments comes from indirect taxes, reform of such taxes needs to be calibrated carefully to balance the conflicting objectives. The announced introduction of VAT at the State level from April 1, 2005 will go a long way in removing the cascading effect of the extant sales tax regime.  A phased rationalisation of the central sales tax to remove tax on inter-State sales and integrate the whole country into one common market, and consolidation of all indirect State level taxes into VAT along with a proper calibration of the VAT rates, can reconcile both the efficiency and revenue mobilization objectives.  Progress towards aligning customs duties to ASEAN levels, which appears to have enhanced competitiveness of the economy and fuelled export growth, needs to continue.  Simultaneously, the consequent loss in revenues of the Central Government, if any, needs to be made up in revenues from other sources and by a phased removal of exemptions. Both the Centre and the States need to improve their tax administrations to have an impersonal and hassle-free regime, with a low compliance cost for the honest tax payer and a high risk for the evader. This can be done through innovative approaches utilizing the power of information technology, not only for information collection, data mining and analysis, but also for automatic collection of tax revenues at source.

1.61  Looking beyond the question of fiscal consolidation through the vigorous implementation of the FRBM Act, there are five issues that need to be addressed to step up investment. First is the issue of investment in agriculture and allied activities, a sector that produces only 21 per cent of GDP, but supports nearly 57 per cent of the population. While there has been some diversification from foodgrains into areas such as fruits and vegetables, floriculture, dairy and poultry, much more needs to be done to encourage such diversification. There is a colossal loss of output due to inadequate storage and transport facilities and lack of sufficient food processing capacities. More public and private investment on these post-harvest facilities is required not only to increase value addition in agriculture but also to improve the link between agriculture and rural industrialisation. It is also likely to have an impact on unemployment and poverty in rural India, which is home to almost 75 per cent of the country’s poor.

1.62  There is a paramount need to move Indian agriculture beyond its centuries’ old  dependency on the monsoon by bringing more area under irrigation and by better water management. This has rightly been identified in the NCMP as one of the areas with the highest investment priority. It is in this context that the appropriate design of the fiscal support to be given to agriculture becomes important. Given the compulsions of fiscal consolidation, the choice is between subsidy for price support to crops, fertilizer, irrigation and power, on the one hand, and higher public investment in supportive infrastructure for irrigation, roads, electrification, agricultural extension and research, on the other. With these investments, diversification of the rural economy beyond not only cereals but also agriculture appears feasible. The vibrancy of agricultural exports observed in recent years can get a fillip from such investments coupled with a stable policy towards agricultural trade.

1.63  Second is the issue of simplifying procedures and relaxing entry-exit barriers. The ease with which firms are able to enter into and exit from business activities is an important determinant of the investment climate.  For business start ups, a large number of clearances have to be taken, both at the Central and State level. Such a system introduces delays and creates avenues for corruption. Studies show that with a heavy regulatory burden on business, India still ranks in the bottom quartile of comparable nations on the ease of doing business. In China, the average time taken to secure the necessary clearances for a start up, or to complete a bankruptcy procedure, is much shorter than in India. Indian labour laws, particularly Chapter VB of the Industrial Disputes Act, 1947, allow firms less latitude than the labour laws do in China, Brazil or Mexico .  Small-scale reservation has not succeeded in producing the expected results, and has constrained investment in some critical sectors, such as knitwear, with large growth potential. There is little justification for continuance of such reservations since all such items are now freely importable. Easing the entry-exit barriers will be critical in determining the success of the textiles sector to reap the enormous potential benefits of the post-quota regime. The recently constituted Investment Commission, with a mandate to interact with industry groups/houses and large companies abroad, secure investments, and also advise the Government on procedures and policies, should help. Similarly, the National Manufacturing Competitiveness Council will also help in focussing attention on the policies and procedures needed to tap the vast potential of manufacturing.

1.64  Third is the issue of finance. The incipient investment boom in infrastructure, industry (including housing), and services will yield best results only if the enormous resource flows are successfully intermediated at a low cost.  It will depend on the ability of the financial sector to process information properly, and convert domestic and foreign savings into optimal investment by specific firms and sectors.

1.65  Farmers and enterprises should have access to finance at competitive rates and for all maturities for their credit-worthy projects. There has been some progress in improving the credit markets in recent years by, for example, establishing vibrant credit information flows through credit bureaus and improving enforcement of debt contracts. The dramatic reforms on the equity market since the early 1990s, with T+2 rolling settlement, screen-based anonymous order-matching, dematerialization, and competition among multiple exchanges, appear to have diversified the investor base. Yet, more needs to be done on both the debt and equity markets. There is need for greater competition and efficiency in banking to bring spreads down, reducing NPAs, improving credit culture, and better credit-appraisal skills to identify the future winners among start-ups and small-scale units. The vibrancy of equity markets needs to be extended to the debt market by moving to a screen-based anonymous order-matching and competition among alternate trading platforms. Subject to prudential norms, the participation of pension funds and contractual saving schemes in equity and long-term debt markets needs to be encouraged not only to benefit industry, agriculture and infrastructure, but also allow the small savers to cash in on the handsome returns that such markets are likely to yield in the medium term.

1.66  Fourth is infrastructure. Infrastructural inadequacy constrains economic growth, particularly in the backward States and in the agriculture sector. For example, fruits and vegetables will perish before reaching the household kitchen, if there are no good roads and no cold-chains. And cold-storages will not work if there is no reliable and adequate power supply.  Similarly, even a wonder of the world tourist site will fail to attract a large number of international tourists if there are no means of rapid transportation and no urban infrastructure around it.  Direct government production of infrastructure services introduces difficulties concerning technical efficiency, adequate scale of investment, proper enforcement of user charges, and competitive market structure. Such direct production, for example, runs the risk of infrastructure, like road construction and maintenance, being misaligned with user priorities and linked more to political interventions and budgetary compulsions. Private participation also mitigates the problem of risk for the public sector, starting from project formulation. At the same time, a complete reliance on private production in an unregulated market is not likely to produce sound results.  The decline in public spending in the infrastructure sector has not been adequately compensated by the private sector mainly due to difficulties in the regulatory environment. Therefore, there is a need to find an appropriate policy framework enabling public–private participation in the infrastructure sector.

1.67  Under minimum subsidy bidding, the potential service provider quoting the lowest amount becomes eligible for subsidy payments.  Eligibility is subject to fulfilling a specified level of performance or service provision obligation. This is a promising strategy for extending infrastructure services to poor consumers in commercially unviable, sparsely populated rural areas, and also for facilities such as roads, sanitation, and waste management, for which complete cost recovery through user charges alone is not feasible. Many countries have deployed this approach in sectors as varied as telecom (Chile, Colombia, Peru and South Africa), electricity (Argentina and Chile), road reconstruction and maintenance (Argentina, Australia, Chile, and the UK), and civil aviation (Australia and the US).  

1.68  Initiatives taken in a number of sectors like telecom, roads, ports and civil aviation have started yielding results. The National Electricity Policy announced recently envisages access to electricity for all house-holds in the next five years and fully meeting power demand by 2012. The structure and composition of the telecom sector has undergone a substantial change with mobile telephones accounting for 50 per cent of the total phones and the private sector accounting for 44 per cent of the total phones. Expansion of the broadband telecom sector will also impact economic growth considerably. In the area of roads, there is a need to shift the focus from construction to corridor management and road safety. Ports need to have an adequate policy framework to promote inter-port and intra-port competition.  Provision of port connectivity through rail and road, and international benchmarking of performance parameters and prices, are very important factors in determining the growth of the port sector. In the civil aviation sector, there is an immediate need to improve regulation and competition in the airline industry, and to build better airports. Given the volatility observed in recent years in international POL prices and the import dependency of the country for crude petroleum, efforts need to continue to enhance energy security by augmenting the infrastructure of trans-border gas pipelines.

1.69  Fifth is the need for higher foreign investment, in the form of foreign direct investment (FDI) and FII.  Such investment triggers technology spillovers, assists human capital formation, contributes to international trade integration and particularly exports, helps create a more competitive business environment, enhances enterprise development, increases total factor productivity and, more generally, improves the efficiency of resource use.  Progressive global integration of the Indian economy has resulted in successful assimilation of many domestic industries in global production chains. Automobiles, software and electronics are important examples. Entry of foreign investment has helped these industries in achieving technological upgradation and higher value addition.

1.70  While trade liberalisation, introduction of greater competition and liberal foreign investment policies have succeeded in transforming several segments of Indian manufacturing into globally competitive entities, there exists a strong case for revisiting the issue of caps in sectors such as coal mining, insurance, real estate and retail trade. Foreign direct investment in retail can not only organize a significant part of the largely unorganized domestic retailing, but can also invite established global retail brands into the Indian market, thereby creating greater outlets for sourcing and marketing Indian products. Organised retail formats will also help in upgrading the quality of products, establishing efficient supply chains from farm to market and generating greater employment.

1.71  Accelerating growth is necessary but not sufficient for reaching out to the poor in the economy. The NCMP emphasizes the need to empower the people through universal education and health care. The direct attack on unemployment envisaged in the NCMP has already been translated into the National Rural Employment Guarantee Bill, 2004, which was introduced in Parliament on December 21, 2004 . The Bill promises to provide for enhancement of livelihood security of the poor in rural areas by ensuring at least 100 days of guaranteed wage employment in every financial year to every household whose adult members volunteer to do unskilled manual work. Employment Guarantee Councils are to be constituted to discharge various functions and duties at the Centre and the States. The success of these schemes will depend on the efficiency of the delivery mechanism. There is need to suitably restructure the administrative machinery and put in place mechanisms for monitoring outcomes. This opportunity must be used actively to build robust rural infrastructure, particularly in backward districts. Furthermore, the additional outlays for these enhanced Government responsibilities need to be met from a rationalization of the subsidy regime, for which a discussion paper was placed in Parliament on December 23, 2004. A consolidation of the various poverty alleviation programmes can also increase the value for money from these programmes. 

1.72  The macroeconomic stability observed in recent years needs to be sustained. The benefits of such stability for investment, protecting the poor and furthering growth are well-known.  Growth in the post-reform period has avoided the pitfalls of earlier decades, when the economy suffered from balance of payments problems. There is a need to build on the growing external strength of the economy, and foster improvements in institutions and infrastructure, which will accelerate the current export momentum.  Growth in India so far, from the demand side, has been mostly driven by private final consumption, with investment and exports playing a minor role, unlike in China and East Asia. The recent buoyancy of investment and exports needs to be enhanced to leverage growth in the Indian economy. Success in this regard will depend on how vigorously reforms are pursued to improve the investment climate and augment infrastructure.