Pressing the Growth Accelerator: Policy Imperatives.

BY RAKESH MOHAN

The paper observes that India’s growth has fallen after the North Atlantic Financial Crisis. It looks
into the factors- macroeconomic variables and policy options- that can put it back on track.

I. Paper Overview:
1. India: Sustained growth over a long period since Independence, though some stops due to business
cycles or other reasons.
2 Institutional system: Significant policy changes made to changing circumstances. However,
sometime delays do exist.
3. Most of growth financed by sustained growth in domestic savings and associated investments.
External savings (FDI, FPI etc): relatively limited proportion of total investment.
So, falling growth associated with stagnant savings and investment, usually due to bad fiscal situation
and higher inflation.
4. Golden age of growth in India: 2003-08. Almost 9% growth.
Other features:
Low inflation, low nominal and real interest rates, improved corporate profitability, reduced fiscal
deficit (subsidies cut and tax/gdp increased-freed resources for private corporate investment).
[Macro identity- USES OF SAVINGS EQUATION: Spvt = I + Govt Deficit + CAB. India: govt
deficit, CAD. IMPLIES THAT WE ARE USING fdi to increase I)]
Growth broad based- covered all the three sectors- agriculture, industry and services.
5. The great slowdown post North Atlantic Financial Crisis (NAFC): 2012-14. Substantial slippage in
Indian growth. Annual average growth under 5-6%.
6. Pressing issue: What is needed to return to 8-9% growth path? Or, what does it imply for key
macroeconomic variables like Savings, Investment, Current Account Deficit, Inflation, Tax/GDP
ratios, Manufacturing growth etc? This is the focus of the paper. Based on a report by National
Transport Development Committee (2014) – India Transport Report: Moving India to 2032.
7. Requirements for such high growth (Similar to China, Japan and other East and South Asian
Countries): Low inflation, Fiscal Quality, Revival of Manufacturing and overall industrial growth,
step-up in infrastructure investment in energy and transport.
Fiscal quality: Govt has cut capital expenditures and increased subsidies . (Eg: Pranab Stimulus in that
near about period)
Subsidies have to be cut,
public investment in capital expenditure to increase (crowds in private investment) and
increase tax/GDP ratio to comparable international levels.
Revival of Mnfg growth: Must be in double digits. VERY WEAK IN OUR ECONOMY.
Requires: appropriate interest rates, competitive real exchange rate, removal of impediments in factor
markets, particularly labour (Article on Indian economy: MISSING MIDDLE size of Indian
companies) and land, location of manufacturing entities within or in the vicinity of cities.
Increased infrastructure investment in both energy and transport: Elasticity of power demand with
respect to GDP around unity. So, need for sustained and continued investment in power generation,
transmission and distribution. Also, need for transport facilities for delivering inputs.
8. Above task more difficult now due to long slow-down in global economic growth and trade.
Silver lining: Weight of global economy shifting to emerging market and developing economies
(EMDEs) in Asia, Latin America and Africa. So, even if contraction in North Atlantic economies
(North America and Europe), impact on global growth likely to be mitigated by counter balancing
growth of EMDEs.

II. Paper Structure:

1. Introduction to the problem.
2.The Indian Economy: A Story of Consistent Growth
Long-term growth dynamics since Independence, special features of 2003-2008 period,
savings and investments, reasons for domestic slowdown during 2012-14.
3. Getting Back to the High Growth: A Simulation for 2017-32.
4. Policy Imperatives for Getting Back to High Growth Path.
For 3 and 4:
Possible growth scenario for the medium to long term (GDP Growth rate): 7% NEAR
TERM; 8-9 % DURING 2017-2032,
Key changes in key macroeconomic variables
Policies required for achieving this growth.
Based on a report by National Transport Development Committee (2014) – India Transport
Report: Moving India to 2032.

III. Introduction to the Problem:

India’s performance before and post NAFC:

 2003-04 to 2007-08: India’s average real GDP growth about 9 % pa.

 2008-09: growth slipped substantially to 6.7 due to both domestic and global factors (NAFC).
 2009-12: Real growth rebounded to average 7.7 % due to large coordinated fiscal and monetary
stimulus. (Pranab Mukherjee : IS-LM or AS/AD analysis : dealing with recessions)
 2012-14: average annual growth under 5-6%. Reasons: low global demand, volatility in
international financial markets on the back of the NAFC, higher domestic inflation, and
governance issues- have led to fall in investment and growth.

Performance of other countries post NAFC

 Slowdown in growth not peculiar to India. Broad-based- affecting EDEs as a whole.

 So, since 2012, EDEs: slow down in a synchronized and protracted manner. Growth rates in
EDES since 2012 lower than the pre-NAFC average in more than 70 percent of the EDEs.
 However, the case for India more severe- indicates presence of domestic factors that have
compounded the global slowdown impact.

Issues in Going Forward

 With adverse external environment: difficult to achieve strong growth momentum of the
2000s in the EDEs over the next 2-3 years even if favourable factor accumulation and
productivity growth of the 2000s to prevail (NOT FOR EXAMS: Growth accounting concept:
Growth due to factor accumulation (INCREASE k and l) and productivity (INNOVATION,
technological progress, efficiency etc. Y = F(K.L)); Y = C+I +G+NX; SAVING EQN
(USES OF SAVINGS IDENTITY). EXCHANGE RATES. CAPITAL OUTFLOWS. (EAST
ASIAN CRISES 1997) (CHINA : K VERY HIGH: APPROX I was 45 % ). EG GCR:
ADVANCED ECONOMIES: INNOVATION
 Recovery in global trade still very subdued: growth rates less than half those recorded in the
1990s and 2000s up to the crisis.
 Perception: extended stagnation in global economy to remain; Risk: world could get stuck for
some time with “mediocre” level of growth

 Similar concerns expressed for India.

Reason: Based on cross-country analysis- abnormally rapid growth rarely persistent;
regression to the mean the most salient feature of economic growth.
Developing countries: episodes of rapid growth frequently punctuated by discontinuous drop-
offs. So, growth in China and India to be much less rapid than currently anticipated.

Recent economic developments: Favourable conditions/Optimism for India

 However, some positive recent developments for India: IMF (2015) downgraded growth
prospects for major EDEs other than India- growth outlook for India unchanged.
 Additional optimism provided by Central Statistical Organization (CSO):

2012-14: upward revision in India’s growth estimates

2014-15: 7% plus advance estimates for growth
Requirements for achieving such growth: Sustained policy efforts on a continuous basis

 Assumption: Some degree of normalcy in global economy and removal of growth impediments in
India in the next couple of years.
 Return to a sustained high growth path in India feasible. The Union Budget 2015-16 (February
2015) push towards infrastructure investment, amidst continued fiscal consolidation, adds to this
realism.
 However, requires sustained policy efforts on a continuing basis. Focus of the paper is to look at
macro variables and policies that will enable such a high growth path in a feasible manner as was
exhibited during 2003-08.

IV. Long-term growth dynamics since Independence, special

features of golden period-2003-2008, reasons for domestic
slowdown during 2012-14.

Independence to pre-golden period

1. Overall Growth dynamics: Secular uptrend over long period except a decline in some
periods due to business cycles or other reasons.
A. Overall GDP:
 As per literature, “Characterized as being slow” after Independence till the late 1970s,
with a pick-up in the later period.
 Reality: Consistent acceleration in growth since the 1950s, except for an interregnum
during 1965–81.

B. Industrial growth

Not slow in the entire 30 years after Independence as often believed. Stagnation only during
the mid1960s.

C. Services
 Continuing and consistent acceleration over the decades that really accounts for the
corresponding acceleration in overall GDP growth, except for the 1965–81 interregnum.
 Nothing particularly special about service sector growth during the 1990s and 2000s,
except that the acceleration over time has continued.

2. The interregnum 1965-81: Darkest period in post-independence Indian economic history.

Reasons: Restrictive policy actions in this period that effectively closed the Indian economy
and slowed down Indian economic growth, just when various East Asian countries were
opening up and accelerating their growth.

3. 1981-1990 to 1991-97: Pick- up in growth

1981-1990: Slowdown witnessed during 1965–81 reversed in 1980s due to reforms for
increasing domestic competitiveness.

1991-97: Growth impulses gathered further momentum in the aftermath of comprehensive

reforms encompassing the various sectors of the economy.

 Reform areas: ex-ante real devaluation of the rupee in 1991, industrial deregulation,
opening to FDI and foreign technology, gradual trade liberalization, substantial reduction
in tax rates and rationalization of the taxation structure, deregulation of interest rates,
reduction in statutory pre-emption, and improvement in the monetary–fiscal interface.
Monetary-fiscal interface improvement: These initiatives included raising market borrowings
at market-related yields, the phasing out of the automatic monetization through ad hocs,
continuous development of the government securities market, enactment of fiscal responsibility
legislation and restrictions on the central bank’s subscription to primary market
 issuances (this is crudely government debt monetization- printing currency to fund the deficit)
(RBI, 2004). (omo: rbi secondary market buys and sells govt securities)
 Impact of reforms: Led to enthusiasm in private sector and thus tremendous increases in
its investment intentions.

4. 1997-2003: Fall in growth

 Causes: Onset of East Asian financial crisis, setbacks to the fiscal correction and quality
(typical issues: subsidy vs capex, revenue deficit vs fiscal deficit of fiscal adjustment
(given below), slowdown in agriculture growth due to poor monsoon, slowed reforms,
monetary tightening to contain inflation, and containment of the excessive enthusiasm
and optimism with regard to investment plans in domestic industry that had followed the
1991 deregulation.
 Key sector affected: Manufacturing.
In every episode of economic slowdown, it is this sector that exhibits sluggish growth;
sustained overall economic growth is then followed by a revival of manufacturing.
So, similar phenomenon this time as well, though some key differences also exist.

[article name: sent on the group - The process of fiscal correction could also not be sustained due
to the pressures from the Fifth Pay Commission award. As a result, by the year 2001-02, all the major
fiscal parameters, viz., revenue deficit, fiscal deficit and public debt rose to levels higher than those
prevalent at the beginning of the reform process. Capital outlays continued to bear the burden of
fiscal adjustment, with the ratio of capital outlays to GDP reaching their lowest levels during the
period 1997-98 to 2002-03, both at the Central and State levels. Reflecting the worsening of the
fiscal situation, the public sector savings rate deteriorated in the second half of the 1990s,
culminating into unprecedented dissavings during the period 1998-99 to 2002-03. This also pulled
down the aggregate saving and investment rates in the economy. Other major components of
domestic savings – the household financial savings rate (at around 10 per cent) and the private
corporate sector savings rate (around 4 per cent) – also stagnated during this period at the levels
reached during the mid-1990s. Consequently, the investment rate also came down from the peak of
about 26 per cent in 1995-96 to around 23 per cent in 2001-02. Concomitantly, the growth process
suffered a setback with the real GDP growth decelerating to 3.8 per cent by 2002-03.]
Golden Era of Growth, 2003-08: Distinct strengthening of the growth momentum

Features

1. Causes of growth: Restructuring measures by domestic industry, overall reduction in

domestic nominal and real interest rates, fiscal consolidation, improved corporate
profitability, a benign investment climate, strong global demand, and easy global liquidity
and monetary conditions.

[In view of the deterioration in fiscal deficits over the period 1997-98 to 2002-03 and rising public
debt, and its adverse impact on public investment and growth, a renewed emphasis was laid on
improving the health of public finances on a durable basis. In order to achieve this objective, fiscal
consolidation has been guided by the Fiscal Responsibility and Budget Management (FRBM) Act,
2003 at the Centre and similar fiscal responsibility legislations at the State-levels. Since 2002-03,
significant gains have been witnessed in the fiscal consolidation process, both at the Centre and the
States, partly as a result of the implementation of the rule-based fiscal policies at the Centre and the
States. A major factor contributing to the durability of the fiscal consolidation process underway in
India in recent years has been the buoyancy in the revenues accompanied by some reprioritisation
of expenditure with a focus on outcomes, unlike the expenditure compression strategy in most other
countries as also the experience in India in the 1990s. The revenue augmenting strategy
encompassed moderating the tax rates and broadening the tax base through expansion in the scope
of taxes, specifically service tax, removal of exemptions, some improvement in tax administration
with a focus on arrears recoveries. Reflecting these measures, the tax-GDP ratio of the Centre has
steadily risen from 8.8 per cent in 2002-03 to 11.3 per cent in 2006-07(RE) and 11.8 per cent in 2007-
08 (BE). The entire increase in tax revenues was mainly on account of the buoyancy in direct taxes.
On the expenditure front, while the total expenditure of the Centre declined from 16.8 per cent of
GDP in 2002-03 to 14.1 per cent in 2006-07 (RE), the capital outlay rose from 1.2 per cent to 1.6 per
cent of GDP. The movement in key deficit indicators reflects the progress made so far in fiscal
consolidation. Fiscal deficit of the Centre and the States taken together has declined from 9.2 per
cent of GDP in 2002-03 to 6.4 per cent in 2006-07 led by reduction in revenue deficit from 6.7 per
cent of GDP to 2.1 per cent. Apart from the quantitative improvement, a salient feature of the fiscal
consolidation underway has been some qualitative progress made as reflected in the reduction in
the proportion of revenue deficit to gross fiscal deficit. As a result, the dissavings of Government
administration declined from 5.2 per cent of GDP in 2002-03 to 1.3 per cent in 2006-07. The savings
of the departmental 6 BIS Review 18/2008 enterprises improved marginally from 0.5 per cent in
2002-03 to 0.6 per cent of GDP in 2006- 07. The major component of public sector savings, i.e.,
savings of non-departmental undertakings, has, interestingly, exhibited a steady improvement since
the 1970s and this process has continued during the reforms period (Table 4). Thus public sector
enterprises have exhibited continued and steady improvement in their commercial functioning since
the early 1990s. Consequently, since 2003-04 onwards, total public savings have turned positive
again. The savings rate of the overall public sector improved from (-) 0.6 per cent of GDP in 2002-03
to 3.2 per cent of GDP in 2006-07. Notwithstanding the striking improvement over the past few
years, it may be noted that the public sector savings rate at 3.2 per cent during 2006-07 was still less
than the peak of over five per cent touched in 1976-77. Nonetheless, the turnaround of 5.2
percentage points of GDP in public sector savings – from a negative 2.0 per cent of GDP in 2001-02
to a positive 3.2 per cent of GDP in 2006-07 – has been a key factor that has enhanced domestic
savings from 23.5 per cent to 34.8 per cent over the same period. The public sector investment rate
increased from 6.9 per cent of GDP in 2001- 02 to 7.8 per cent in 2006-07, but this level is still
significantly lower than the public sector investment rates of the 1970s, 1980s and early 1990s.
Despite this increase, this sector’s saving-investment gap has narrowed down from 8.9 per cent of
GDP to 4.5 per cent during 2001-2007, reflecting a turnaround in the public sector savings (which
rose from (-) 2.0 per cent to 3.2 per cent) enabled by the implementation of the fiscal rules.]

2. Growth broad-based: agriculture, industry and services – contributed to the momentum.

3. Marked acceleration in both public and private investment.
4. Fiscal Deficit Decreased
 Causes: Gross tax/GDP ratio of the Central government increases and reduction in
subsidies.
 Impact: Freed up resources for investment by the private corporate sector. So, higher
public sector and private corporate sector savings rates AND broadly stable household
savings rate LED TO increase in the overall savings rate. THIS LED TO significant
increase in domestic investment.
5. Low inflation in this high-growth period: It was broadly similar to that in the preceding
period, even under higher global commodity inflation. CAUSES:
 Good monetary management: Multiple instruments and innovations used to contain
impact of huge inward capital flows. For example, market stabilization scheme
(innovation) used to sterilize the impact of large and volatile capital flows.
 [ high powered money includes foreign assets. If fpi/fdi increases then hpm increases .
thus money supply increases]

 Government’s agricultural support price policy: Favourable towards inflation control.

 Increase in minimum support prices in respect of agricultural commodities during 2003-
08 lower than that in 1997-2003, which in turn was lower than in 1991-97.
6. Improved financial sector (improvements in asset quality and efficiency indicators)
contributing to increased private sector investment.

[Performance of the private corporate sector

The reduced requirement by the Centre for meeting budgetary mismatches, and for overall public
sector financing has improved the availability of resources for the private sector considerably.
Furthermore, the corporate sector has responded to increased global competition by improving its
productivity and efficiency through increased application of technology. The economic reform
process has helped greatly in making the policy environment more conducive for more efficient
entrepreneurial activity. The corporate tax rate was steadily reduced from 45 per cent in 1992-93 to
30 per cent by 2005-06 and was kept stable thereafter. The peak rate of customs duty on non-
agricultural goods was reduced gradually from 150 per cent in 1991-92 to 10 per cent in 2007-08.
Monetary policy has contributed to the sustained moderation in inflation leading to reduction in
nominal interest rates. Financial restructuring of firms has also led to the reduction in overall debt
equity ratios in the corporate sector. The substantial reduction in debt servicing costs has thereby
added to the corporate sector’s competitiveness and profitability. Profits after tax recorded an
annual average growth of around 47 per cent per annum over the 4-year period ended 2006-07
(Table 5). Profit margins have recorded large gains, while the interest burden has witnessed a
significant decline. In fact, the ratio of interest expenditure to sales revenues fell from around 6 per
cent in the 1990s to about 2 per cent now, thereby contributing greatly to the enhanced profit
growth. The profit after tax (PAT) to net worth ratio, after declining from 14.4 per cent in 1995-96 to
5.1 per cent in 2001-02, increased to 16.6 per cent 2005-06 (Table 6). Another notable feature of
performance of the corporate sector in the recent period is the progressive increase in retained
profits, which as a share of PAT, increased from 30.9 per cent in 2001-02 to 73.6 per cent in 2005-06.
The improved profitability, reflecting improved productivity and lowering of tax rates, enabled
corporates to deleverage their balance sheets. This was reflected in the sharp decline in the debt-
equity ratio. The improved corporate financial performance resulted in doubling of the private
corporate sector saving rate (from 3.9 per cent in 2002-03 to 7.8 per cent in 2006-07), which has also
contributed to the pick-up in the overall savings rate. From the long-term perspective, it is
interesting to observe that the rate of savings of the private corporate sector has increased from
around one per cent in 1950s, 1.7 per cent in 1980s and 3.8 per cent in 1990s, to almost 8 per cent
now. Higher retained profits along with availability of resources from the banking sector facilitated
by the lower financing requirement of the Government and the increased access to the domestic
and international capital markets led to a sharp increase in the investment rate of the corporate
sector from 5.7 per cent of GDP in 2002-03 to 14.5 per cent in 2006-07. Thus, despite the increased
savings rate, the saving-investment gap of the corporate sector widened from 2.1 per cent of GDP in
2001-02 to 6.8 per cent in 2006-07.]

7. Infrastructure investment increase: about 1 per cent of GDP. Contributed to the high
growth in manufacturing and trade.
 Increase divided roughly equally between the public and private sectors, thereby
increasing the share of private sector investment in infrastructure.
 Roads benefitted, but railways stagnant (as a share of GDP).

Consistent Growth in Savings and Investment

[Household savings: Exs. House, land, farm implements.

Definitions: http://mospi.nic.in/136-saving-and-capital-formation

More on household sector: https://www.livemint.com/Opinion/lcM37ksqu14EhduQ4GVt8J/What-

ails-Indias-household-economy.html)

Household Savings and Investment: https://www.businesstoday.in/current/economy-

politics/decoding-slowdown-dip-in-household-savings-investment-an-indicator-of-structural-econ]

 Indian economic growth financed predominantly by domestic savings. So, domestic

growth associated with increasing domestic savings and investment over the decades.
 Gross domestic savings: increased from an average of 11 per cent of GDP during 1950–
65 to over 33 per cent of GDP in 2003–08.
 Domestic investment rate: increased from 12 per cent to 34 per cent.
 However, long-term upward trends in savings and investment have been interspersed with
phases of stagnation, influenced particularly by developments in government finances.
 Foreign savings (FDI, FPI etc)—equivalently, current account deficit (CAD) —have been
rather modest. Also, increases in CAD, as in 1960s and 1980s (towards 2 per cent of
GDP) and in 2011-13, have been followed by significant balance of payments and
economic crises.

[Spvt = I + Govt Deficit + CABalance(surplus/deficit)]

Post golden period- reasons for domestic slowdown during 2012-14.

 Growth slowdown during 2012-14: After almost a decade of consistent high growth,
including a sharp recovery from the 2008-09 crises.
 Reflects six factors:
1. Macroeconomic policy response to the NAFC – both monetary and fiscal policy:
Response was rapid. However, there was overshooting of stimulus, sowing seeds for
inflation and current account pressures. Subsequent monetary tightening (demand side),
though somewhat tepid, then dampened economic activity and growth. Also, as there was
persistent inflation in food items (Supply side factor). Monetary policy was relatively
ineffective in taming inflation. It had to stay in a relatively tighter mode for a longer
period.
2. Quality of the fiscal stimulus:
 Focus on tax cuts, increased revenue expenditure (particularly in subsidies) and stagnant
capital outlays. Led to demand pressures, leading to high inflation.
 Thus, growth recovery in 2008-12 based on very large growth of government
consumption (%) (high fiscal and revenue deficit). (Y = C, I, G, NX)
 Also, withdrawal of fiscal stimulus (G inc, T dec, S inc etc) hesitant and slow (increased
revenue deficits of centre and states).
 Finally, increase in public investment in roads and power increased along with the fiscal
stimulus in 2008-10 by promoting public-private partnerships (PPPs). However, this
witnessed a decline later. Contributed to the growth slowdown, particularly in
manufacturing and key infrastructure sectors.

3. Delayed and incomplete withdrawal of the fiscal stimulus:

 Led to crowding out of the private sector.

 Possibly hampered private corporate investment: Extraordinary growth in gross fixed
capital formation observed in 2003-08 almost halved in 2008-12.
 High nominal interest rate environment (due to monetary tightening), along with subdued
growth, also impacted corporate profitability and investment. The availability of domestic
resources for the private corporate sector squeezed from all sides.
3. CAD widened well-beyond comfort levels by 2012-13.
 Growth in volume of global exports of goods as well as “goods and services” during
2012-14 one-third of 2003-07 period. Also impacted Indian exports and overall
growth.
 High domestic inflation and negative real interest rates on deposits encouraged gold
imports;
 Incomplete pass-through of international crude oil prices to domestic fuel prices led to
greater demand for imported petroleum products; (we are paying lesser than market
rates?)
 Increased pressure to CAD due to appreciation pressure on the real exchange rate from
large capital inflows: (MACRO IDENTITY RELATING TO FOREX from soumyen
sikdar)
In contrast to previous episodes of large capital flows, there was little foreign exchange
intervention. So, foreign exchange reserves were not increased and the real exchange rate
appreciated while the CAD widened. In fact, capital inflows were encouraged through
continued opening of the capital account, particularly to potentially destabilizing debt
flows.
4. Near collapse of manufacturing growth in 2012-14:
 Near zero mfg. growth in this period (based on index of industrial production (IIP))) –
almost unprecedented for the Indian economy since independence.
 Difficult to understand since until 2012, manufacturing growth averaged in excess of 8
per cent.
 Given the macroeconomic factors outlined above – some monetary tightening, higher
inflation, private sector crowding out, slowdown in global demand and real exchange rate
appreciation (X dec), slowdown expected but collapse to zero growth puzzling.
 Emergence of policy bottlenecks: Obtaining environmental permissions, fuel linkages, or
carrying out land acquisition stalled large number of projects. This possibly discouraged
 new investment (Government of India (GoI), 2013), particularly in infrastructure projects
and manufacturing.
 Restoration of sustained high overall growth critically dependent on reinvigoration of the
manufacturing sector.

6. Data complications. (not really so imp: 1 or 2 line)

 Caution required in analyzing recent industrial performance based on the index of

industrial production (IIP). IIP data in the past has indicated much lower growth than
ASI. (For 2008-12, average annual industrial growth figures: IIP- 4.7%, ASI data (net
valued added adjusted for wholesale price index (manufactured products) inflation) 9.1
%).
 However, in 2012-13, ASI lower than IIP [(-) 2.5 percent versus 1.1 percent]. ASI data
for 2013-14 are not yet available.
 Further, a new series on National Accounts Statistics (NAS) released in January 2015,
with 2011-12 as the base year. The difference is attributable to the change in the
compilation methodology for manufacturing from the factory-level value addition
approach (based on ASI data) to the headquarter-level value addition (based on the
Ministry of Corporate Affairs database); the new methodology now captures in-house
services like marketing and presents full value of what that company is delivering
(Sen, 2015).
 Revised NAS series: Manufacturing growth- 6.2% and 5.3% vis-à-vis 1.1% and (-) 0.7 %
in the earlier (2004-05 base) for 2012-13 and 2013-14, respectively. So, a more thorough
assessment of these growth dynamics and the intensity of the slowdown would be
possible once a consistent data series for the earlier years is also available in the new
series.
 Summary: VERY GOOD STARTING POINT FOR ANSWER WRITING All these
macroeconomic and policy developments contributed to the Great Slowdown during
2012-14.
o Overall, the key policy messages from the 2012-14 slowdown reinforce the
messages from the 2003-08 high growth phase: need for prudent fiscal policy, a
low and stable inflation environment, appropriate capital account management,
maintenance of a competitive real exchange rate, and a focus on infrastructure
investment.
 o The 2012-14 episode also flags the issue of containing the CAD within prudent
limits, although the CAD is ultimately a reflection of other domestic
macroeconomic and financial policies.

III. GETTING BACK TO HIGH GROWTH: A SIMULATION FOR 2017-32

[ For writing data for this section, write in the form of Table below:

Variable One or two past Assessment Projections

years (India) Year (India) 2017-32 (India)
Eg.
1. GDP Growth
2. S
Hh S
Pvt Cor S
Govt S
3. I
4. ICOR
and so on.

Like this, do for all sections as per requirement.]

The projections aim to provide a consistent macroeconomic framework and their implications
for returning Indian annual GDP growth to around 7 per cent in the near future and then
ascending to 8-9 per cent in the following quinquennial periods from 2017-2032. The results
then provide some assessment of the feasibility of achieving such a growth objective, should
the return to such a growth path be seen to be within the realms of reality? Another way of
interpreting these projections is to see the results as implications of achieving such a high
growth path: what they imply for the evolution of key macroeconomic variables.

1. Actual Per-Capita GDP and Overall GDP in 2013-14: US$1500 and US$1.9 trillion.
2. Growth target over the next couple of decades (based on performance of past two to three
decades): Double per capita income in each of the next two decades.

Growth (%s): 7 % (Per Capita) and 8% (Overall GDP).

Numbers: Per capita income around $6000 (2011-12 BASE prices) by 2035 and GDP around
US$ 8.5 to 9 trillion.

3. Assessment of growth target:

 Realistic?
India’s GDP would be just over a half of US GDP today (2012-14), and per capita income
would be about 12 per cent of the current US level. Thus, target is reasonable but
ambitious.
 Feasible?
Growth would be comparable to that of East Asia’s ten-fold GDP increase over about 30
years (1975-2005).

Only a handful of countries have achieved this and escaped the “middle income trap”.

Thus, to achieve the target will require sustained efforts, given the continuing high levels of
poverty in India. For instance, significant increase required in domestic investment and
saving levels from their current somewhat depressed levels.

4. Targets for Macroeconomic Variables: Based on National Transport Development Policy

Committee (2014) in its recent “India Transport Report: Moving India to 2032”. (INTDN
TO ANSWER ON THIS PAPER)

[Methodology: Can be omitted

1. Simulations rely on the fundamental accounting identity of standard national income

accounts, and include detailed information on key items such as investment and
consumption/savings (disaggregated into public and private components) and net
exports/imports.
2. Projections of these components, in turn, are based on past relationships and trends,
while also considering the government’s announced medium-term fiscal plans.
3. They are also conditioned on the expected practice of sound macroeconomic and
financial policies.
4. The growth and investment relationship draws upon historical productivity estimates
reflected in incremental capital output ratios, supported by estimates on total factor
productivity that has been achieved in recent years.
 5. Implications of the investment and growth projections for balance of payments – both
current and capital accounts – and the overall external sector sustainability are also
factored in, while also imposing a cap on the recourse to sustainable foreign savings.
6. The projections are the preferred point estimates, picked following consultations with
a broad range of stakeholders in government and in the private sector (NTDPC,

2014)).]

Magnitudes of Savings and Investment: Sustained increase projected.

1. Gross domestic capital formation (GDCF) or Investment rate: 35% in 2012-13, about
39% and 43 % during 2017-22 and 2027-32 respectively.
2. Domestic Savings rate: 36% and 41% during 2017-22 and 2027-32 respectively.
3. Envisages an increase in all the three major components of savings – household,
private corporate and public (Table 3).
4. Assessment:
 Projections ambitious, but reasonable and achievable as domestic savings and
investment rate were 37 and 38% respectively in 2007-08.
 Further, the secular uptrend of Indian savings and Investment rates since
Independence (although interspersed with some short periods of stagnation), also
makes it likely.
5. Absorption of external savings (fdi/fpi): kept at around 2.5 per cent of GDP
throughout the period, consistent with a sustainable CAD. [(bop india : cad + capital
account surplus (due to inflow of forex due to fpi/fdi=0)]
6. Assumptions:
Projections contingent on pursuit of sound and stable macroeconomic and financial
policies and continuing structural reforms (elaborated later).
7. Implications on efficiency (ICOR), balance of payments, capital flows, desired
foreign exchange reserves and other variables discussed below.

Overall efficiency of the economy (ICOR, a crude measure of productivity): ICOR of about
4.2 over the next couple of decades given target growth paths of GDP and GDCF as
discussed above.

1. International best ICOR values: 3.5 to 3.6.

2. Indian ICORs: Between 3.5 and 4.5 during past 30 years (Chart 1).
3. So, a high level of efficiency in resource use assumed.
4. Assessment:
 Consistent with Indian historical achievements.
 Also consistent with other recent evidence on productivity based on total factor
productivity growth (TFPG) (RBI (2014)).

(Note: TFPG: Measure of productivity. If TFPG increases then ICOR decreases)

TFPG growth: Increased from 1.1% pa during 1980s and 1990s to 2.3% during the 2000s
(2000-01 to 2008-09), led by manufacturing and service sectors (Chart 2).

Contribution of TFP growth to real GDP growth: 21% during the 1980s and 1990s. 30%
during the 2000s.

For next two decades: at least the same as in 2000s, especially if infrastructural
shortages are addressed satisfactorily. Will also increase growth prospects.

5. Overriding Assumption: Strong sustainable manufacturing growth revival (about 10%)

necessary.
 GDP growth rates in excess of 8 % not feasible without manufacturing growth
revival (about 10%) even with optimistic agriculture growth of 4% pa. This rate of
manufacturing growth achieved during 2005-08, but collapsed to almost zero
during 2012-14.
 Share of manufacturing in GDP will even then not exceed 15% even then while
that of agriculture is expected to fall below 10% in 20 years.
1. Financing Growth.
How investment projects could be financed?

OR

Sources of Domestic and External Financing.

I. Domestic Savings: How the different constituents of savings - household savings, private
corporate sector savings and public sector savings- should behave.

Projections of different types of savings rates (% of GDP):

1. Household Savings: 28% by 2027-32. Financial Savings: 13% by 2027-32.

2. Private Corporate Savings: 9.5% by 2027-32.
3. Public Sector Savings: 3% in 2017-22 and 3.4% by 2027-32.

 Household savings: Financial and Physical Savings (Gold, Real Estate etc.)

1. Bedrock of domestic savings in India: Increased steadily over the years. Very important for
financing investment in public and private sectors.

2. Values (% of GDP): 21 during 1997-2003, 24 during 2008-12.

3. Projected increase: 28 by 2027-32.

4. Net household financial savings (?): increased from about 6-7% of GDP during the 1980s
to about 10% in the 1990s, stabilizing at this level thereafter. Recently, fallen to around 7%
per cent, savings directed to gold. (https://www.livemint.com/news/india/the-significance-of-
household-financial-savings-11592154490780.html)

5. Expected to be restored to the earlier 10 per cent level in near future, as inflation subsides,
monetary conditions stabilize and households begin to obtain positive real interest rates on
their deposits and other financial savings. Projection for 2027-32: 13%.

6. Form of financial savings: Increasing shares to contractual saving such as insurance,

provident and pension funds. Likely to get accentuated with urbanization as needs for
insuring against retirement increase. Also benefitted by unfolding demographic structure (rise
in working class).
7. Assessment of projection: Reasonable, due to increased financial depth and inclusion with
increase in income.

 Private Corporate Savings:

1. Performance during golden era of growth (2003-08):
 Rise from 3.9% of GDP during 1997-2003 to about 7.8% during 2008-12.
 High levels of profitability allowed high retained earnings that helped greatly in
financing high levels of corporate investment.
2. Necessary to restore confidence in future Indian growth for corporate investment to
increase again in the next couple of years.
3. Restoration of private corporate investment requires improved profitability so that private
corporate savings again reach about 7.5% of GDP within the next 3-4 years.
4. Projections: 9.5% by 2027-32.

 Public Sector Savings: Public authorities and non-departmental commercial enterprises.

(Public authorities: Government administration and “departmental enterprises” (non-

corporatized commercial government enterprises (e.g. railways)).

Non-departmental Enterprises: Corporatized public sector enterprises).

1. Savings turned distinctly negative due to the fiscal stimulus of 2008-09. They were mildly
positive, 0.5% in 2007-08, a remarkable turnaround from (-)5% in 2000-01. Negative
savings broadly correspond to the revenue deficit of the Centre and States combined.

2. Both departmental and non-departmental public enterprises- maintained consistent positive

saving rates of between 3.5 and 4.5 per cent of GDP over the past decade and a half.

3. Government savings still negative due to slow unwinding of the fiscal stimulus or the fiscal
and revenue deficits. Signs of some improvement in last few years. This will not only will
public sector savings improve but also reverse the crowding out of the private sector (uses of
savings identity).

4. So, essential that fiscal correction takes place over the next 2-3 years: As revenue deficits
of central and state governments approach zero, government savings could again attain
positive levels as in 2007-08. Only then will it be become feasible for private sector
investment to increase to the magnitudes projected.

5. So, projected overall public sector savings: From current level of just over 1% of GDP to
3% in 2017-22, rising to 3.4% by 2027-32. It is possible that even greater improvement can
take place, particularly if the overall tax/GDP ratio can be improved over the years.

Summary of this section:

The plausible projections of savings for each of the three segments is expected to increase
gross domestic savings from current 31-32% to about 36% in 2017-22 and 41% in 2027-32.

II. External Savings

Key projections:

1. CAD to be 2.5% of GDP.

2. A relatively slower pace of export growth (goods and services) at 11-12% between 2017
and 2032.
3. Exports of goods and services to increase from the current level of about 25% of GDP to
about 30% in 2017-22 and 38% in 2027-32.
4. Foreign exchange reserves from current 16% of GDP to about 19-20% in 2017-22 and
22% in 2027-32.
5. In absolute terms, this means net annual capital flows would be about $135 billion in
2017-22 and $330 billion in 2027-32 (at 2012-13 prices).

[forex reserves based on: trade growth projections, debt servicing, financial stability due to
volatile FPI and other flows (increasing financialization in the world economy and advances
in technology that makes financial markets very quick to adjust and transact]

1. Recent years, stress laid on mobilizing external savings to finance Indian investment for
growth, particularly in infrastructure.

2. The maximum feasible level of external savings that can be mobilized to finance overall
investment in India should be based on its sustainability of servicing such inflows over time.
(This was done in the NTDPC modelling framework by utilizing a debt sub model which

projects the implications of debt flows servicing needs over time). (NEW LINK: debt
and non debt creating foreign capital:
https://www.bis.org/publ/bppdf/bispap44m.pdf)

3. For a country with an increasing size of its economy, even relatively small proportions of
its GDP start assuming large absolute magnitudes from the point of view of international
capital markets.

4. Net capital flows absorbed by an economy as a whole are identically equal to the CAD.

5. Considerations for sustainability indicate that the CAD should not exceed around 2.5
percent of GDP on a continuous basis.

5. As the CAD increased to levels exceeding 4 per cent of GDP in 2012-13, we have already
seen the kind of instability that can be caused by adverse developments in international
financial markets.

(General ARTICLE on CAD and impact on economy

1. https://www.financialexpress.com/what-is/current-account-deficit-meaning/1616290/,

2. https://www.thehindu.com/business/Economy/what-is-current-account-deficit-and-why-does-it-
matter/article24842306.ece,

3.Detailed Indiainfoline: https://www.indiainfoline.com/article/news-top-story/economics-for-

everyone-current-account-deficit-cad-113110810453_1.html))

6. Indian exports grown: Healthy pace since 2002, significantly faster than world exports.

Total exports of goods and services: Almost doubled as a share of GDP between 1998-2002
and 2008-12, reaching a level of about 22 per cent of GDP. Except for 2008-09 and 2009-10,
which were crisis years for global trade, Indian exports of goods and services have been
growing at 20-25 per cent per year since 2002.

7. In view of the protracted current slowdown in global trade, and the low probability of a
revival of the high growth rates achieved earlier, a relatively slower pace of growth at 11-12
per cent between 2017 and 2032 is projected.

8. Even at this pace, exports of goods and services would increase from the current level of
about 25 per cent of GDP to about 30 per cent of GDP in 2017-22 and 38 per cent in 2027-
32. 9. By way of comparison, the current level of exports of goods and services of China
amounts to about 31-32 per cent of its GDP.
10. Imports of goods and services are projected to grow correspondingly while keeping a
sustainable level of CAD at about 2.5 per cent of GDP.

11. Such projections of exports and imports will not be feasible without the corresponding
growth in all aspects of investment in transport, logistics, ports and airports.

12. If India’s external account expands in the manner projected, and as India’s economy and
its financial markets become more open, it will be necessary to build foreign exchange
reserves in a prudent manner, so that financial stability can be maintained even in the face of
the inevitable capital flow volatility.

13. Foreign exchange reserves have been posited to be maintained at a level of about 6
months of imports of goods and services on a consistent basis.

14. The projections suggest that this would imply an increase in foreign exchange reserves
from the current 16 per cent of GDP to about 19-20 per cent in 2017-22 and rising to 22 per
cent in 2027-32.

15. At present, Chinese forex reserves amount to about 18 months of imports and 41 per cent
of GDP.

16. Such an expansion of reserves would also be consistent with the required expansion of
base money, the Reserve Bank of India’s balance sheet, which is necessary to fuel the
monetary expansion consistent with GDP growth.

17. Thus, the consistent need for accretion to forex reserves implies that net capital flows will
need to be in the region of about 4.5 per cent of GDP during 2017-32, if the CAD is kept at a
level of about 2.5 per cent of GDP. This would allow annual reserve accretion amounting to
about 2 per cent of GDP over the period.

18. In absolute terms, the implications of such a scenario are that net annual capital flows will
need to be about $135 billion in 2017-22, rising to about $330 billion in 2027-32 (at 2012-13
prices).

19. From an external sustainability point of view, and given the more volatile nature of debt
flows, the projections assume that the equity component will dominate, at 60-65 per cent of
net capital flows, with debt flows (35-40 per cent) being the residual. These proportions are
also broadly consistent with the prevailing debt equity ratios in the Indian corporate sector.
Key lesson from this exercise:

Even if the CAD is kept at a modest range of around 2.5 per cent of GDP, total net capital
flows that will be needed amount to large and growing magnitudes over the medium term.
There will, therefore, be a need to ensure high external confidence in the Indian economy so
that such external capital flows are forthcoming.

Concepts from Soumyen Sikdar: BOP identity.

II. Infrastructure Investment: Significant pick-up required in
the coming years for stable and sustainable growth.
Projections:

1. Overall infrastructure spending: 8% of GDP during the 2020s and beyond.

2. Share of Public Sector: 57% during 2017-2022 (could go up further due to problems
in financing of PPPs).
3. Share of Indian Railways in total infrastructure: From current 0.4% of GDP to 1% and
above by 2017-22 and for next decade and a half.
4. Total investment in transport, both public and private: increase from about 2.6%
during the 11th Five Year Plan to about 3.3% during the 2030s.
Public sector component: 2.1- 2.2% of GDP.
Private sector component: 1.5-1.6% of GDP.

1. Achieving a high sustained rate of economic growth requires corresponding investments in

infrastructure, including all aspects of transportation.

2. If industrial growth is to be ratcheted up to growth rates of around 10 per cent, and if there
is to be the kind of trade growth projected, the demands for the provision of power,
transportation and logistics will also grow commensurately.

3. The continued expansion of trade requires corresponding investments in ports, airports,

and in all forms of domestic transport linkages.

4. Projections for overall infrastructure investment: increase substantially from around 5.4%
of GDP in 2011-12 to around 8% during the 2020s and beyond. This is consistent with the
economic growth and transformation experiences of South East and East Asian countries
(Tables 4 and 5).

5. Assessment of projections: Realistic.

It had reached 6.2-6.3% in 2008-10. So, aiming for 7% in medium term and 8% later is
realistic.

6. Share of public and private investment and their areas:

 Increasing proportion of infrastructure investment to be undertaken by the private sector;
but a predominant role still for the public sector. Fiscal consolidation required to carry out
this role of public sector.
 Public sector share: 57% of the total infrastructure spending in 2017-22, somewhat lower
than the current estimate of 60 percent; Could become higher in view of difficulties in
implementation and financing of PPP projects. However, it is important that such
investments be remunerative with high economic returns.
 Areas for public sector: Electricity, railways, and roads and bridges.
 Areas for private sector: Communications, ports and airports.

7. Roads infrastructure investments: Significant success over past two decades.

 Joint initiation of the National Highways Development Project (NHDP) and the Prime
Minister’s Gram Sadak Yojana (PMGSY) has since 2000.
 Improved road connectivity between major cities on the one hand, and within rural
areas, on the other.
 Contributed to productivity enhancements that have benefitted the economy as a
whole.
 Overall investments in roads tripled from 0.4 per cent of GDP in the late 1990s to
around 1.2 per cent by the late 2000s.

8. Similar need for railways: Still lagging.

 Share of Indian Railways in total infrastructure to be raised from the current level of
about 0.4% of GDP to 1% and above by 2017-22 and continuing at similar levels for at
least the next decade and a half.
 Essential for improving productivity of the manufacturing sector overall.
 Also important for linking inland nodes to ports to aid in the sustained growth required in
trade, both exports and imports.
 So, a specific requirement for the expansion of railways capacity to transport bulk freight
like coal and iron ore and steel in the volumes that will be necessary to fuel overall
economic growth.
 Power demand elasticity with respect to GDP: About unity.
 So, generation of power expected to increase four-fold, along with the projected
GDP increase over the next couple of decades.
1. Such growth in power generation implies an increase in the corresponding
demand for coal by at least a factor of three.
2. Requires major enhancement in carrying capacity of Indian Railways, as
existing railways freight capacity is fully utilized. So, program for
Dedicated Freight Corridors (DFCs) needs a similar focus, as was the case
of NHDP that transformed the Indian road system.
 Corresponding investments also needed for expanding port infrastructure for
import of energy commodities, both oil and coal, along with containerized freight.
9. A symbiotic relationship between efficient transport provision and industrial growth.

 Target: Total investment in transport, both public and private, to increase from about
2.6% OF GDP during the 11th Five Year Plan to about 3.3% during the 2030s.
 Public sector component: 2.1- 2.2% of GDP.
 Private sector component: 1.5-1.6% of GDP.
 Assessment: Realistic.
The much-enhanced level of investment in roads over the past decade or so relative to
previous periods demonstrates that it is possible to achieve such an accelerated growth in a
short period of time.

IV. POLICY IMPERATIVES FOR GETTING BACK TO THE HIGH GROWTH

PATH

A. Introduction.

1. The objective of taking growth back to around 9 percent and the required increase in savings and
investment rates will need very significant policy reform in a range of different activities.
2. Is it feasible?
 That such reform has been carried out on a relatively continuous basis since the early
1980s, intensifying in the 1990s and accentuated in the infrastructure sector since the
mid-1990s, gives confidence in the potential ability of the country’s policy making
system to rise to the challenges of the future.
 In principle, Indian institutional capacity for governance and reform has exhibited
considerable resilience, although the institutional development and reform needed to get
to the next steps in the ladder towards achieving middle income status will be of a much
higher order than that achieved in the past.

3. We focus on five key areas of policy action.

 First, Indian public finances have to be brought back to an even keel so that resources
start becoming available for increased public investment in infrastructure. Most attention
in this area is typically devoted to containment of the fiscal deficit through expenditure
containment. We argue that, while current expenditures, particularly those on subsidies,
do need to be contained, it is now time to give as much attention to increase revenues
through enhancement of the tax-GDP ratio.

 Second, private savings, both household and corporate, need to be brought back to their
earlier levels. A sustained reduction in inflation that leads to the maintenance of low
nominal interest rates, but positive real interest rates, will help in restoring corporate
profitability, while encouraging household savings towards financial instruments.

 Third, the external account has to be managed on a continuous basis so that external
savings can be attracted in adequate magnitudes, while ensuring external stability, and
maintaining a competitive real exchange rate.
  Fourth, recognizing that there has been a significant slowdown in manufacturing growth,
specific measures need to be taken to revive manufacturing and then accelerate
competitive manufacturing activity. There has to be a much greater focus on labor using
manufacturing to take advantage of the expected shift of such manufacturing away from
China in the coming years.
 Finally, it must be recognized that the achievement of high sustained economic growth,
particularly in manufacturing, is not feasible without a step up in infrastructure
investment, particularly in transport with an emphasis on the railways.

B. We now turn to elaboration of each of these areas.

I. Public Savings and Fiscal Policy

1. Fiscal consolidation is necessary for sustained growth in an environment of macroeconomic

and financial stability.
2. A key factor that has led to a decline in the domestic savings rate since the NAFC has been the
increased revenue deficit of the central government.

3. The government reaffirmed its commitment, in the Union Budget 2015-16, to pursue
fiscal consolidation, by reducing the fiscal deficit to 3.0 percent of GDP by 2017-18.
4. The aim must be to eliminate the revenue deficit completely and then move towards a small
surplus.
5. It would then be possible to limit government borrowing exclusively for public investment
purposes in both social and physical infrastructure.
6. This would be critical to enable domestic savings to finance growth of 9 percent and above in
a sustainable manner.

7. On subsidies:
 The increase in subsidies, from 1.4 per cent of GDP in 2007-08 to 2.5 percent in
2012-13 has been a key component of the increased revenue deficit (Table 6).
 Enhanced fuel subsidies to kerosene, diesel and LPG constituted the main component of
this increase.
8. Policy Objective:
 The policy objective must be to bring back overall subsidies to be in the region of about
one per cent as has been achieved earlier.
  Such a move would free up around 1 to 1.5 per cent of GDP for public investment in
infrastructure.

9. The government completed the process of eliminating diesel subsidies in an incremental

manner and announced deregulation of diesel prices in October 2014.

10. A similar process could be followed for reducing or eliminating LPG subsidies.

11. The sharp drop in the international crude oil prices in late 2014, if sustained, should facilitate
an accelerated adjustment in this direction. The phased elimination of such subsidies would
also allow for a more efficient use of petroleum products. The challenge will be the
maintenance of deregulated prices when oil prices rise again.

12. The demand for petroleum products is generally adjudged to be relatively price inelastic. In the
Indian context, the problem has been compounded by the relatively sticky administered prices.

13. However, the empirical evidence in Kapur and Mohan (2014) shows that demand for oil in
India does respond to prices in a significant manner: the estimated price elasticity of demand
for petrol is (-) 0.66, for diesel is (-) 0.36 and for kerosene oil is (-) 0.54.
 14. Thus, the elimination of fuel subsidies will be beneficial for growth in a number of different
ways:
 Reduction in revenue deficit, leading to increase in government savings, and
reduction in the crowding out of the private sector;
 Sustained reduction in the CAD as a result of reduced demand for fuel;
 Higher overall efficiency in the use of energy, and hence in overall economic activity;
and;
 Provide more resources for growth-enhancing public investment in infrastructure. In this
context, the decision of the government in January 2015 to increase the basic excise duty by
Rs. 2 per liter on both petrol and diesel to fund infrastructure projects, especially roads, is also
a welcome step.

15. The second issue with respect to fiscal policy is that the recent fiscal consolidation
efforts have been focused excessively on reduction in expenditure, and particularly in capital
expenditure. Consequently, revenue expenditure has increased. This needs to be reversed.

Improving Tax/GDP Ratio

1. On the revenue side, the gross tax/GDP ratio of the Centre has recorded a significant fall from its
peak of 2007-08 of 12 percent, to 10 per cent in 2013-14 reflecting the stimulus measures and
weakening of economic activity.
2. The revenue receipts (net)/GDP ratio of the Central government is now below the levels
prevailing in the late 1980s – reflecting the lower tax revenues as also perhaps more devolution to
States (Chart 3).

3. Cross- Country Analysis on government revenue/GDP ratio:

 Cross-country analysis indicates that the general government revenue/GDP ratio in India is
quite low, even considering its per capita income (Chart 4).
 The revenue/GDP ratio in India has declined since the NAFC, even as this ratio has increased
in other major EME regions.
4. Corporate and Income Tax comparisons:
  A comparison of India with the OECD countries indicates that the corporate tax revenues in
India are higher than in the OECD (3.6 percent to GDP versus 3.0 percent in 2011) (Chart 5).
 In contrast, the personal income tax revenues in India are found to be significantly lower than
the OECD (1.8 percent to GDP versus 8.5 percent in 2011) (Chart 6).

 This pattern is also evident in other emerging and developing economies (Abramovsky,
Klemm and Phillips (2014).

5. Other issues in Income tax and Corporate Taxes:

Income Tax

 Low income levels in India can partly explain the relatively low personal income tax
collections in India.
  However, it appears that the income tax rates are also notably lower in the Indian context.
 This is true for both the peak income tax rate as well as the income thresholds at which the
various tax rates kick in (Chart 7).
 For example, the peak income tax rate in India was 30 percent in 2013, whereas it averaged
36 percent in the OECD countries; in as many as 15 OECD countries, the peak personal
income tax rate was 40 percent and above.

 Also, the minimum income tax rate averages 10 percent in the OECD countries vis-à-vis zero
on India, although this specific comparison is complicated by differences in basic exemptions
and credits across countries.
 Turning to an analysis of the income thresholds levels, the peak income tax rate in India is
applicable to annual incomes of Rs. 1 million and above, i.e., almost 11 times the per capita
income in 2013. The corresponding OECD average was 4 times the per capita income (Chart
8).

 Information on taxpayers
1. Available information indicates that there were only 3.6 million people in 2011-12 :
just 0.3 percent of the country’s population - who reported taxable incomes above
Rs.500,000 (Table 7).
2. By way of comparison, we may note that the number of passenger vehicles sold in the
country in 2011-12 was 2.6 million.
3. Here, it is also relevant to note that the category of taxpayers with incomes above Rs.
1 million normally gets substantial dividend income, which is currently tax-free in the
hands of the investor as the company distributing dividend pays dividend distribution
tax at the rate of 15 per cent.
4. Hence, such high-income individuals are taxed at a lower overall effective marginal
rate than those having little or no dividend income.
5. The need to focus on expanding this category of taxpayer base, therefore, is crucial at
this point (GoI, 2014a).
6. As noted earlier, the peak income tax rate in India of 30 percent is well-below that in
the OECD countries and moreover, the peak rate in India kicks-in at much higher
(relative) income levels.
7. The Union Budget 2015-16 addresses this issue to an extent through the proposed
surcharge of 2 percent for assesses with taxable income above Rs.10 million.

Corporate Taxes
 As regards corporate taxes, the Indian tax rate is somewhat higher than that in the OECD
countries (Chart 9).
 However, the effective tax rate is notably lower than the statutory rate, although the gap has
narrowed somewhat in the last few years (Chart 10).
 The Union Budget 2015-16 proposes to address this issue through reduction in the corporate
tax rate to 25 percent over the next four years, accompanied with rationalization and removal
of various exemptions and incentives.

6. Cross-country evidence on tax base broadening and tax revenues:

 Broadening the tax base (including through withholding taxes etc) the key to increasing
tax revenues in many low-income countries (Besley and Persson, 2014).
 This is true for advanced economies as well.
1. For example, the Scandinavian tax systems have very wide coverage of third-
party information reporting and well-developed information trails ensure a low
level of tax evasion.
2. Moreover, broad tax bases in these countries further encourage low levels of tax
avoidance and contribute to modest elasticities of taxable income with respect to
the marginal tax rate. (?)
3. The subsidization or public provision of goods and services complementary to
working including child care, elderly care, transportation, and education -
encourages a high level of labor supply. Such public provision of labor
complements implies that the effective labor supply distortions are less severe
than implied by the tax-transfer distortion claims (Kleven, 2014).
4. Tax compliance is as high as 90 percent in advanced economies, if third party
information practice exists; the compliance rate increases to 99 percent if both
withholding and third party information practices exist.
7. Increasing Tax/GDP Ratio in India:

 Overall, there appears to be considerable room for increasing the tax/GDP ratio in India.
 The net result of a sustained thrust on tax compliance in all areas – both direct and indirect
taxes –
should result in greater buoyancy in the tax/GDP ratio than has been experienced in the past.
 This can be achieved without any major increase in tax rates, through widening of the tax
base and rationalization of exemptions.
 The number of income taxpayers can be increased from the present 35 million to at least 60
million; a wider legal tax base increases equity as well as compliance (GoI, 2014a) .

8. Fiscal Correction and Public Savings

Taking into account the fiscal correction that is being programmed as also the fiscal consolidation
record of 2002-08, and greater efforts at compliance, public sector savings should recover in the
manner projected.

Gross domestic savings rate could then increase by around 2-3 percent of GDP, or even higher.
A similar event occurred about 10 years ago when public sector savings had become negative
(Mohan, 2011b).

The envisaged fiscal correction will make more resources available to the private sector and
contribute to the recovery of private sector investment and profitability and hence private sector
savings.

9. Infrastructure

 It is well recognized by all that infrastructure investment is critical to loosening supply side
constraints and promoting manufacturing.
 Fiscal consolidation is also important here:
1. Despite increasing private investment in infrastructure, it is necessary to enhance
public investment in infrastructure on a sustained basis.
2. The case for higher public investment now is also on account of limitations of the
public private partnership (PPP) projects seen in the country in the recent past (GoI,
2014b).
3. Here, it is also relevant to note that cross-country evidence indicates that increased
public infrastructure investment raises output in both the short and long term,
particularly during periods of economic slack and when investment efficiency is high.
4. Debt-financed projects could have large output effects without increasing the debt-to-
GDP ratio, if clearly identified infrastructure needs are met through efficient
investment (IMF, 2014d).
5. However, if the efficiency of the public investment process is relatively low, due to
poor project selection and execution, increased public investment leads to more
limited long-term output gains.

10. Summary

 Thus, along with better project selection and execution, the culture of economic user charges
must be reinforced so that infrastructure investment is remunerative.
 Second, with increasing incomes, expenditures on non-merit subsidies must be curtailed and
directed toward infrastructure investments.
 And, as argued earlier in this section, there is a significant scope to improve the Indian tax
revenue/GDP ratio through better tax administration and a wider tax base for direct taxes.
 As regards indirect taxes, the introduction of the Goods and Services Tax (GST) Bill in the
Lok Sabha in December 2014 is encouraging and its early enactment is expected to provide
higher revenues as well as efficiency gains.
  Strong fiscal consolidation on these lines, along with quality of its adjustment, would provide
a conducive environment for higher domestic savings, lower domestic interest rates and, more
flexibility to monetary policy in its operations.

II. Household Savings and Management of Inflation

1. Overall household savings in 2012-13 were only marginally lower than the peak attained in 2007-
08,.
2. However, there has been a significant change in the composition of these savings, with a
pronounced shift away from financial savings towards physical savings.
3. This shift affects adversely the availability of resources for the rest of the economy, especially the
private corporate sector.
4. Hence, ensuring positive real returns on bank as well as postal deposits in an environment of low
and stable inflation is necessary to reverse the downward trend in household financial savings
along with focused thrust on contractual savings schemes.
5. This endeavour can be expected to be facilitated by the agreement (February 2015) on monetary
policy framework between the Government and the Reserve Bank.

6. With increasing urbanization and longevity, one might have expected a greater shift in financial
savings towards contractual savings such as provident and pension funds and life insurance
products as the financial sector got diversified.
7. Given that the vast majority of Indian household savers continue to be in the middle income
categories, they exhibit a marked preference for safe savings avenues such as postal savings and
public sector bank deposits.
8. Since there is really no social security worth the name in the country, and pensions are available
to only the privileged few, there would be significant unmet demand for safe assets that provide a
mildly positive real rate of return.
9. Thus, there is a pressing need for the provision of savings vehicles that meet such demand in the
form of simple, easy to understand, pension and life insurance products which combine some
elements of defined benefits while remaining predominantly defined contribution schemes.
10. Not only will such schemes provide much needed elements of social security, they would also be
ideal for financing infrastructure projects that typically need long term finance.

11. As persistently high food inflation has been a key driver of headline inflation, monetary policy
will have its limitations. Accordingly, policies aimed at improving productivity and output in
agriculture through reorientation of government spending way from current spending (fertilizer,
power and irrigation subsidies) towards capital outlays will be extremely helpful. Appropriate
 policies with regard to minimum support prices are also critical (Bhalla, 2013).

12. There also needs to be better recognition of the changing diet of Indian consumers towards non-
cereals including fruits, vegetables, poultry, meat and dairy products. With increasing incomes
and accelerating urbanization, demand for these products will continue to grow much more than
that for cereals.
13. Without the existence of appropriate rural infrastructure and an efficient supply chain, including
refrigeration facilities in both warehouses and trucks, the markets for these products remain
segmented to limited geographic areas within the vicinity of cities. Burgeoning non-cereal food
demand will therefore contribute to inflation on a consistent basis giving rise to wage pressures
and more generalized inflation, and loss of competitiveness.
14. Summary:
 Inflation containment will therefore also depend on a more focused roll out of rural
infrastructure in terms of both transport and energy, mainly a public sector function.
 Specific policies are also needed to promote private sector activity in investing in the
overall agriculture supply chain as the basic infrastructure is enabled.

III. Private Corporate Sector and Manufacturing

The private corporate savings rate has declined by more than 2 percentage points between 2007-08
and 2012-13.

1. This reflects reduction in profitability on the back of the slowdown in aggregate demand and
the impact of higher interest rates necessitated by the persistence of inflation.
2. Success with fiscal consolidation and inflation management will allow lowering of nominal
interest rates, which will allow higher corporate profitability and higher corporate savings.
3. Persistently high inflation during 2009-13 has also added to some exchange rate
overvaluation during this period, and this is clearly visible from CPI-based real effective
exchange rate indices. (REAL EXCHANGE RATE = E (Nominal Exch
Rate)*Phome/Pforeign)
(DEFINITION OF REER, NEER
https://www.imf.org/external/region/tlm/rr/pdf/Nov5.pdf)
(Overvalued and undervalued exchange rates: When it is believed a depreciation of the
currency is needed to balance trade, they will say the currency is overvalued. When it is
believed an appreciation of the currency is needed to balance trade, they will say the currency is

undervalued. http://internationalecon.com/Finance/Fch30/F30-6.php#:~:text=When%20it
%20is%20believed%20a,say%20the%20currency%20is%20undervalued.
https://www.eastasiaforum.org/2010/03/06/is-the-indian-rupee-overvalued/
 Problems of overvalued exchange rates:
https://www.economicshelp.org/blog/2882/currency/problems-of-overvalued-exchange-
rate/)
4. Success with inflation management will also provide a conducive environment for stability in
the real exchange rate, which will encourage exports, manufacturing activity and corporate
health, while also contributing to the as well as contribute to sustainability of the current
account deficit (Kapur and Mohan, 2014).
Globally, rapid industrialization and manufactured exports have been the most reliable levers
for rapid and sustained growth. Virtually all countries that have sustained high growth rates
for decades have done so on the back of manufacturing, with growth miracles of Japan, Korea
and China being conspicuous illustrations of this phenomenon (Rodrik, 2013,
2014; Timmer et al, 2014).
5. Thus, policies that promote manufacturing activity in India will have a key role.
6. Although the cross-country evidence indicates that the structural change in favor of
manufacturing has softened in many countries and some countries are exhibiting premature
deindustrialization. The newly initiated “Make in India” campaign is a clear recognition of
this issue.

7. Although the Indian factor endowment is abundant in labor, Indian manufacturing has not
been generally competitive in labor using sectors: there needs to be focused effort at
correcting this, much as China and other East Asian countries have done over the past 30-40
years.
8. This involves the tackling of legacy issues connected with regulatory impediments that
constrain the use of both land and labor in Indian manufacturing.
9. There has been a traditional prejudice against the location of industries in Indian cities, which
is where skilled labor is likely to be available. Urban land ceiling regulations and other zoning
requirements have traditionally limited the availability of urban land for industrial
development. Thus, whereas in other successful manufacturing oriented cities it is not unusual
to find multistoried structures housing labor using industries such as clothing and other light
industries, such manufacturing is almost totally absent in Indian cities.

10. There is a new window of opportunity that is emerging over the next 5 -10 years as labor-
using manufacturing moves out of China as wages rise in that country. The current trend is for
these activities to move to South East Asian countries such as Vietnam, Philippines,
Cambodia and Bangladesh.
11. A focused effort to address constraints emanating from labor and land laws will be critical for
promotion of manufacturing in the country.

12. There has been longstanding discussion of labor legislation hindering investment in labor
using industries, along with small scale industry reservations. The latter impediment has now
largely been removed, but labor legislation problems remain. The measures needed are well
known, but it has so far not been felt to be feasible politically.
13. The way forward has to include quick labor reforms accompanied by programs that promote
social security for labor such as unemployment insurance and practical training and retraining
programs.
14. Recent initiatives in this direction are noteworthy.
15. For example, Rajasthan has introduced some major reforms in three labor legislations - the
Industrial Disputes Act, the Factories Act and the Contract Labor Act – to provide more
flexibility to create more jobs and enhance ‘ease of doing business’ (GoI, 2014b).
16. The threshold limit required for prior government permission before effecting layoff,
retrenchment or closure has been increased from 100 workmen to 300 workmen under the
Industrial Disputes Act, along with an improvement in compensation and financial security
for the retrenched employees.
17. The thresholds of 10 and 20 workers were increased to 20 and 40, respectively, under the
Factories Act to reduce the ‘Inspector Raj’ related hassles.

(EXTRA RECENT: https://www.thehindu.com/business/Industry/Government-revives-talks-

to-revamp-Factories-Act/article14246055.ece

https://www.thehindubusinessline.com/opinion/the-muchvilified-labour-inspector-
raj/article7519064.ece)

18. The grant of a Presidential Assent has allowed the reforms to take hold and supersede any
constraints that may be imposed by overlapping central laws.
19. Summary:
 It is this combined and focused approach to urban land and labor reforms, along
with the maintenance of a competitive real exchange rate, that can accelerate
manufacturing investment in labor using industries.
 India has also exhibited competitiveness in heavy industries also such as steel,
aluminum, automotives, and others. Such industries are more affected by governance
issues related to environmental and other approval processes that have suffered in
recent years, and from inadequate infrastructure.
  Some of the approval process issues are already being addressed and perhaps need
further focus.
 In addition, it goes without saying that the efficient provision of power, transport, and
logistics is also
necessary for promoting such growth.

IV. Foreign Savings and Capital Account Management

1. The Indian experience as well as of that of other economies indicates that high reliance on
foreign savings increases vulnerability to financial crises.
2. Opening the financial account appears to raise the frequency and severity of economic crises.
3. Benefits of financial openness are most likely to be realized when implemented in a phased
manner, when external balances and reserve positions are strong, and when complementing a
range of domestic policies and reforms to enhance stability and growth (CGFS, 2009;
Obstfeld, 2009).

4. Debt capital flows increase vulnerability to future crises, and this was clearly seen in the
NAFC.
5. EDE regions such as Central and Eastern Europe which saw a large increase in debt flows and
also had large current account deficits did face crises in the aftermath of the NAFC, while
other EDEs did not.
6. Given the structural growth, inflation and interest differentials in favor of EDEs, a fully open
capital account would inevitably lead to large flows in search of arbitrage – creating booms
when they come in and a bust once they leave.

7. Thus, management of debt flows assumes importance. Indeed, one factor that reduces India’s
external vulnerability, despite large twin deficits, is the fact the public debt is largely
internally held.

8. It would be prudent to continue with this approach and further opening up of the government
securities market to non-resident investment needs to be carefully watched and calibrated.
9. Debt investments by non-residents in domestic securities are more volatile than in equity and
can add to foreign exchange market pressures.
10. More often, these flows react to monetary policy developments in advanced economies, as
was the case in mid-2013. This issue is especially relevant at the current juncture, given the
continued near zero policy rates in the US and other major advanced economies, and the
likelihood of an extended continuation of very low interest rates.
 11. There is a view that the traditional fears about foreign-currency borrowing by residents are
not applicable to investments by non-residents in local-currency denominated bonds and
hence the limits on the latter category of investments should be removed (Patnaik et al, 2013).
Such a notion was clearly disproved during the June-August 2013 turmoil. (Muneesh Kumar
Mohan 2013, pg 251)

12. Overall, it is evident that volatility in monetary policy in the major advanced economies is a
source of volatility in capital flows and exchange rates in the emerging and developing
economies.
13. Swings in capital flows, if not managed properly, are often associated with macroeconomic
and financial imbalances and potential financial crises in these economies.
14. The international monetary architecture is characterized by asymmetry (Mohan, Patra and
Kapur, 2013). Notwithstanding significant spillovers from the advanced economy monetary
policy to the emerging and developing economies, international monetary coordination is
skewed and restricted among the major advanced economy central banks only. The lack of
international monetary coordination and its adverse consequences were evident during the
2013 taper episode (Mohan and Kapur, 2014; Rajan, 2014).
15. Before the NAFC, it was the EDEs which typically complained of the adverse impact of
volatile capital flows. After the onset of the NAFC and with extended UMPs (unconventional
monetary policy measures) in the major advanced economies – earlier, the US and now, in
early-2015, the European Central Bank – other advanced economies have also started feeling
adverse consequences of the UMPs in the major reserve currency economies.
 For example, Switzerland and Denmark have been forced to move to a regime of
increasingly negative policy rates – “competitive monetary easing” – to discourage
capital flows from the reserve currency economies.
 In the face of large speculative capital inflows, Denmark was forced to suspend
issuance of domestic and foreign bonds in January 2015.
16. Summary:

These developments, the prevailing international economic arrangements and the weak empirical
evidence on the benefits of open capital accounts all highlight the need for continued prudence in
reliance on foreign savings and continued capital account management.

V. Transport Infrastructure

1. We have outlined the magnitude of growth needed in infrastructure investment overall and in
transport investment in particular.
2. We have also noted that even for the kind of growth needed in power generation, for example, it
will not be feasible without corresponding expansion in transport capacity.
3. The same is true for the expansion of basic industries like iron and steel and other heavy
industries.
4. We therefore argue that transport planning and programming for transport, and adequate
investment in transport needs a new approach.
Much of the thinking on transport in India has been project centric and done within
single-mode silos.
5. The focus has been on stepping up investments to address specific problems usually well after
serious logistic and transport dislocations have become more than apparent. Even the Five Year
Plans were essentially collections of standalone projects, which were not necessarily connected.
6. To achieve significant improvement in overall productivity and efficiency, it is imperative that
future development of the network should be aimed at a better integration of the various modes so
as to facilitate the development of multimodal transport, within the country for the expansion of
exports and imports.
7. So a key requirement for thinking on transport strategy is that it must be system based: it must cut
across modes of transport, administrative geographies and integrate capital investment (both
public and private) with regulatory and policy development.
8. Thus, the country must develop planning capacity in transport that, on the one hand develops
coherent medium and long-term transport strategies, but on the other, is able to respond on an on-
going basis to changes that occur over time in both technologies and relative prices.
9. The NTDPC has proposed the setting up of “Offices of Transport Strategy” at both the national
and state levels, so that transport investment can be planned and programmed adequately. If this is
done, investments in roads, railways, ports and airports can be coordinated so that network
efficiencies can be achieved.

10. Within such a systems approach, the key transformation needed is in railways.
 Much of investment in Indian railways since independence has been incremental:
route expansion has been marginal and technological upgradation has been limited.
 For the kind of overall economic growth envisaged to become feasible, a
transformational approach needs to be taken for modernizing and expanding Indian
railways.

 A key innovation which is already underway is that of setting up a network

“Dedicated Freight Corridors (DFCs)”, similar to the NHDP in roads. Once this is
done in the major trunk freight corridors, freight transportation by rail will become
much more efficient.
  It could then begin to regain its lost share over the decades, particularly as
investments are done in the modernization of rolling stock enabling multimodal
transport.

 Simultaneously, as the freight traffic goes to DFCs, passenger trains can be speeded
up and capacity can be expanded significantly.

 For all this to be achieved, major reform has to take place in the Indian Railways so
that its capacity expansion and technical upgradation can be enabled. The Indian
Railways Report (2001) and the NTDPC Report (2014) have provided detailed blue
prints on how this can be done.
 For our current purposes, we confine ourselves to saying that a business-as-usual
approach to railways investment will not do and urgent action has to be taken now to
initiate the kind of investment projections.

Please do not modify this document without consultation.

Pragya Shankar
Faculty (Economics)
Ram Lal Anand College.

EXTRA

Impact of financial crises on economy: Asian financial crises.

1. https://www.economicshelp.org/blog/glossary/financial-crisis-asia-1997/: more than enough for

understanding.

2. https://www.investopedia.com/terms/a/asian-financial-crisis.asp

3. https://www.britannica.com/event/Asian-financial-crisis

4. https://www.thebalance.com/what-was-the-asian-financial-crisis-1978997
Question Bank

Long Questions: 15 marks (About 6.5 pages).

Short Question: 7.5 marks (About 3.5 pages)

Planning, Market and State.

1. What was the development strategy of Indian planners at the advent of planning in the
country? What role was visualized for the State in the Fifties.

2. Discuss the evolution of strategy and priorities of all XII FYPs (Five Year Plans) in India.

3. Short Questions

(a) Discuss the roles that the Government, State and market must play in development.

(b) Discuss the Relevance of Planning Commission. In this light, discuss the Role and
Functions of Niti Ayog.

Assessment of Growth Experience: Poverty, Inequality and

Unemployment.
1. Briefly describe the problem of poverty in Indian development planning. Discuss the
method and trends in Indian poverty with an attention to the methods for selecting the
poverty lines.

2. Discuss the relation between growth and poverty. Compare the performances of India and
China with regards poverty reduction. What measures should be adopted to make growth
inclusive (reducing poverty)?

3. What is inequality? How is it measured? Discuss the various aspects of inequality. What
are its causes and consequences? What should be done to reduce it?

4. How has employment been addressed in the various FYPs for improving development?
Discuss the following in the Indian context:

(a) Employment, Unemployment and Labour Force Dynamics.

(b) Underemployment: A continuing characteristic of employment.

5. Discuss:

(a) Characteristic and Structure of Indian Labour Market.

(b) Trends and patterns of employment growth; Patterns of employment growth across
primary, secondary and Tertiary Sectors.

6. Discuss for India:

(a) Overall sectoral pattern of employment.

(b) Long term perspectives for improving employment situation in the country.

7. Sum up key features of employment situation in India. What should be done to address the
employment challenge?

8. How can labour market reforms improve employment generation? Discuss the policy
agenda for improving employment.

9. On NREGA. Discuss:

Overview, Performance, Success stories and Gaps of the Scheme.

10. Short Question:

Discuss the employment perspective for the country. What is the skill development
challenge? How should it be addressed?
Pressing the Growth Accelerator: Policy Imperatives.
1. Discuss: The Indian Economy is a Story of Consistent Growth
(Discuss the long-term growth dynamics since Independence, special features of 2003-2008
period, savings and investments, reasons for domestic slowdown during 2012-14).
2. Discuss the evolution of key macroeconomic indicators required for achieving high growth
(Getting Back to the High Growth: A Simulation for 2017-32).
3. Discuss the policy stances required for achieving high growth Policy Imperatives for
Getting Back to High Growth Path.

Financing the Plans

1. What are the various sources of financing the FYPs in the country. Which are the two most
important ones? Briefly discuss the consequences of high fiscal deficit.
2. Discuss in detail the impact of high fiscal deficit due to high borrowing for financing the
plans. What are the methods for addressing this problem?
3. Discuss all financing issues of X and XI Plan Projection.

14th Finance Commission

1. Discuss the key recommendations of the Fourteenth Finance Commission.
2. Discuss the evolution of Indian Federalism and the Assignment Problem.
3. Discuss the trends and issues in fiscal imbalances. Also discuss the major issues in Federal
Fiscal Arrangements.
4. Short Question
With regards to Intergovernmental Transfers, discuss the following:
(a) Economic Rationale for Transfers.
(b) Design of Intergovernmental Transfers.
5. With regards to Intergovernmental Transfers, discuss the following:
(a) Intergovernmental Transfers in India.
(b) Shortcomings of Intergovernmental Transfers in India.
(c) Equalizing effects of Intergovernmental Transfers.