Synopsis
of Economic Survey
Chapter
1: Introduction
A stable political
arena and a supportive external environment are showing a sign of double digit
growth for India. After a long time India get this rare opportunity because of
easy launch of reforms and challenges in various developed and developing nations.
This atmosphere is perfect to encourage investors to put their money though
there are some endurable challenges. This survey will mostly will talk about
two themes: creating opportunity and reducing vulnerability.
Government
is taking various measures like direct benefit transfer to provide growth
opportunity in rural India. Four issues which held back Indian private
investment are weak corporate balance sheets, an impaired banking system,
difficulty of exit, deficiencies of the public private partnership (PPP) model
in infrastructure.
Weak corporate balance sheet talks about
the higher debt to equity ratio, in which company has obtained the maximum
level of debts possible. So, they incur high finance cost and due to it, costs
of the goods or services increase. Apart from it, if they further need
investments, they will have to bring it through equity and raising capital
through equity is costlier compared to debt. This is so because cost of debt is
fixed and expected returns on the capital by shareholders (equity) is higher
than cost of debt.
An impaired banking system shows the
increasing percentage of NPA
(Non-Performing Asset, A classification used by financial
institutions that refer to loans that are in jeopardy of default. Once the
borrower has failed to make interest or principal payments for 90 days the loan
is considered to be a non-performing asset) for Indian banking
industry [Refer table 1]. Increasing NPAs lead to less investment as capital is
blocked up. This reduces the money circulation in the market and also impacts
the profitability of the company.
Easy
of exit is equally important as easy of entry. Slow processing of law and
judicial system of India obstruct the path of exit whereas other Asian
countries like Malaysia, China and Thailand are getting the advantage because
of ease entry and exit barrier. Business report of World Bank 2013 says that
time taken in years shown in bracket, is good indicator of ease of exit: India (4.3); China (1.7); Malaysia (1.5) and
Thailand (2.7). Though there is an improvement after Companies act, 2013, it is
still a way behind the competitive countries. The fact is that no other country
needs permission from government to close a business.
Government
is facing challenges to provide growing demand of better infrastructure
service. As available source of getting fund from traditional source to
implement many projects at a time is quiet impossible, Government is looking
PPP as alternative choice to improve infrastructure. But problems lies in some
generic issues like inadequate transparency of procedures, inappropriate risk
allocation, improper project appraisal, cost and time overruns, overlapping of
regulatory independence and dearth of good governance. The focus is more on
private sector investment because it will lead to high and sustainable growth
rate.
India
is following the growth path of major economies who were adopted manufacturing
and trade as the growth engine in era of post-war period. It is also
experienced that the employment
elasticity (Employment elasticity is a measure of the percentage change in
employment associated with a 1 percentage point change in economic growth)
of manufacturing sector is more than any other sector. This is the sole aim of
encouragement manufacturing sector.
Table : 1
|
||||||
Gross and Net NPAs of Public Sector Banks since
2000-01 to 2012-13 (Amount in Rs. billion) |
||||||
(Per cent)
|
||||||
Year
|
Gross NPAs Amount
|
Gross NPAs as
percentage of Gross Advances
|
Gross NPAs as
percentage of Total Assets
|
Net NPAs Amount
|
Net NPAs as percentage
of Net Advamces
|
Net NPAs as percentage
of Total Assets
|
2001
|
546.72
|
12.4
|
5.3
|
279.77
|
6.7
|
2.7
|
2002
|
564.73
|
11.1
|
4.9
|
279.58
|
5.8
|
2.4
|
2003
|
540.9
|
9.4
|
4.2
|
248.77
|
4.5
|
1.9
|
2004
|
515.37
|
7.8
|
3.5
|
193.35
|
3.1
|
1.3
|
2005
|
483.99
|
5.5
|
2.7
|
169.04
|
2.1
|
1
|
2006
|
413.58
|
3.6
|
2.1
|
145.66
|
1.3
|
0.7
|
2007
|
389.68
|
2.7
|
1.6
|
151.45
|
1.1
|
0.6
|
2008
|
404.52
|
2.2
|
1.3
|
178.36
|
1
|
0.6
|
2009
|
449.57
|
2
|
1.2
|
211.55
|
-0.9
|
0.6
|
2010
|
599.26
|
2.2
|
1.3
|
293.75
|
1.1
|
0.7
|
2011
|
746
|
2.4
|
1.4
|
360
|
1.2
|
0.7
|
2012
|
1124.89
|
3.2
|
1.9
|
593
|
1.5
|
1
|
2013
|
1644.62
|
3.6
|
2.4
|
900
|
2
|
1.3
|
Source: (i) RBI. Handbook of Statistics on the
Indian Economy, 2005-06, 2013-14 |
||||||
MACROECONOMIC
REVIEW AND OUTLOOK
There is a dramatic
change in some macro-economic variables like decline in inflation (CPI) below
6% (Refer Fig 1.2), Foreign portfolio flows (of US$ 38.4 billion since April
2014) which have helped to stabilize the rupees and these reflect in surge in
equity prices (31 per cent since April in rupee terms and even more in dollar
terms). After 12 quarter phase of deceleration there is an average growth rate
of 6.7% and 7.2% onwards. As a result of it, there is an improvement in the overall
MVI (Micro Vulnerability Index is
sum of a country’s fiscal deficit, current account deficit, and inflation)
where as other countries continuing with the status quo or degrading. There is
also an improvement in the macro-economic vulnerability index, RIRI (Rational Investor Ratings Index)
is computed by averaging a country’s GDP growth rate and its macro-economic
indicators; the latter measured as the average of the fiscal deficit, current
account deficit, and inflation (all with negative signs). Thus, equal weight is
given to growth and macroeconomic stability. The greater the number, the better
should be its Investor rating), which shows the risk and rewards of the competing
destinations. [Refer Fig 1.2 and 1.3 for MVI and RIRI].
Fig 1.1
Source: RBI
Source:
Economic Survey 2014-2015
Macro-economic
Management and Policy Reforms:
Myriad reforms
are initiated in the major areas and there is a favourable trade shock which
increases government savings and private consumption. This
shock has happened due to 50-55 percent decline in the prices of the crude-oil
and the other commodities. Looking at the uncertainty of these shocks, India
has appropriately hedged the risk by reducing the oil price 17% in domestic
markets compared to 50% reduction in the international markets that is, 66% price
benefits of the trade shock resulted in government savings.
OUTLOOK FOR GROWTH:
In the short run,
boost for the growth comes from the lower oil price, monetary policy easing
facilitated by lower inflation, expected inflation and forecast of normal
monsoon. The two successive repo rate cut (First 25 bps on 15th
January, 2015 and another 25 bps on 4th March, 2015) and reduction
in SLR (50 bp effective from 7th Feb 2015) by RBI. Medium term
growth will be controlled by increase in private sector investment.
There is an
expectation of rise in real GDP growth by 0.6% to1.1% compared to the growth
rates of 2014-15. Decrease in oil prices and monetary easing will increase the
spending power of household. This factor can also help to increase the profit
margins and thereby improve the corporate balance sheets.
OUTLOOK FOR REFORM:
Several reforms
shall improve the growth and investment. The objective should be clean tax
policy which will facilitate easy business environment. Below are the required
reforms:
-
India
should look forward to increase revenue to GDP ratio which is estimated as 19.5
by IMF for current year whereas this ratio is 25% for emerging Asian economy
and 29% emerging market countries in G20.
-
There
is a need of switch from public saving to investment.
-
To
provide legal certainty and confidence to investors, the ordinances on coal and
land need to be translated into legislation approved by Parliament.
-
There
is need of constitutional amendment of GST
(Good and Service tax is a value added tax which will replace all indirect tax
levied on goods and service by both central and state government) followed by
ratification by state. This amendment
will reduce cascading effect of on product and services encourage investment by
reducing high cost of compliance and tax administration and discouraging
litigation due to frequent change in tax laws and procedure.
-
Similarly,
there is need for efforts on direct tax side.
-
Government
and RBI need to work together to prepare a de facto practice to maintain the
current inflation levels.
-
Reforms
in labour and land laws are required to reduce the cost of doing business
Fig: 1.4
Country
|
Tax as % of GDP
|
Australia
|
25.8
|
34.4
|
|
32.2
|
|
17
|
|
43.6
|
|
44.6
|
|
40.6
|
|
40.4
|
|
17.7
|
|
28.3
|
|
42.6
|
|
39
|
|
26.9
|
Source: World Bank 2009 Data
Chapter
2: Inflation and Money
Inflation in the recent times had
been on an upward trajectory and became an important issue for the new
government to tackle. But of late there have been structural shifts in the
inflationary process due to easing of crude oil prices, deceleration in
agriculture prices and rural wage growth rates. This in turn has had a dramatic
effect on household inflation. The momentum of inflation, measured as
Seasonally Adjusted Annual Growth Rate (SAAR) surprisingly has declined from
nearly 15 percent to 5 percent (Figure 2.1) and moreover food prices have
declined more to the level of inflation.
Figure
2.1
Source: Economic Survey
2014-15
This
momentum likely to persist because of striking developments in three areas that
signal a structural shift in inflationary process in India:
1.
Crude
oil: First, India is highest importer of crude oil after
USA and China. The import of crude oil is a major factor in inflation. These
imports have gradually come down and are expected to go down further (Figure
2.2).
Figure
2.2:
The
decline in crude prices has been due to the following reasons:
·
Weaker global demand: Demand will remain
soft because of slow growth in major economies, including China and Europe.
·
Increased supply: Increased supply in
crude oil and Shale Gas production
in US (Figure) and the concomitant decline in the oligopolistic power of OPEC
(mainly Libya and Saudi Arabia).
·
Global Monetary and liquidity
environment: The abnormally low interest rates cycle in the US ended further
increasing the supply.
Figure
2.3:
Figure 2.4:
However,
the recent attack on Libyan oil fields
by Militant groups and increased tension between Ukraine and Middle East has
surge Oil prices for Asian trade. Unabated fighting has
seen the output of crude oil output reduced from a high of almost 1.5 million
barrels a day to 0.15 million from Libya. In Ukraine, latest efforts to prop up
a ceasefire in the country's eastern region, currently controlled by pro-Russia
had worsened the situation there which curbed supply from Middle East. This has
curbed supply from OPEC countries and prices have risen.
2.
Agriculture:
India’s
inflation will be shaped by agriculture. The major moderating inflationary
pressure in agriculture comes from the continued decline in rural wage growth
rates (Figure 2.5).
Figure
2.5:
Source:
Economic Survey 2014-15
3.
Inflation
Expectation: Recently, Household surveys of inflation
expectation conducted by RBI showed that expectation is stubbornly persistent
above the level of inflation. But recently it had come down by 7 to 8% (Figure
2.6) due to household expectation from new Central Government.
Figure
2.6:
Source:
Economic Survey 2014-15
Chapter
3: Agriculture
India’s
primary sector is Agriculture as 54.6% of population has been directly or
indirectly engaged in this sector. The two important crops, Kharif and Rabi,
have major contribution in this sector. The advance estimates of Kharif and
Rabi crops indicate lower production as compared to last year. However CSO had
estimated positive growth of agriculture despite lower rainfall and following a
good year 2013-14. The deeper shift in agriculture may be under way as there will
be shift as seen in Index of Term of
Trade (ITT).
ITT is the index showing value of a country's exports relative to that of its imports. If a country's terms of trade (TOT) is less than 100%, there is more capital going out (to buy imports) than there is coming in. A result greater
than 100% means the country is accumulating capital (more money
is coming in from exports).It has been improving since several
years is marginally going down from 2010-2011(Figure 3.1) mainly due to global
agricultural prices having peaked. As this ITT deteriorate the as a result
Rural incomes comes under pressure which led political pressure to support will
increase.
Figure 3.1:
Source:
Economic Survey 2014-15
The
response is for short run to support most vulnerable in agriculture i.e. small
farmers and agricultural labourers. The MNREGA program will be well targeted to
use it for build-up of assets like roads, micro-irrigation and water
management. For medium term, India needs to enhance the distorted and
unintegrated market which needs one national common market for agricultural
commodities by making of Agricultural Produce Market Committees (APMCs) just
one among many options for farmers to sell their produce.
There
are wide differences in the yields in different states (Table 1). The yields
are self-sustainable. If we are able to get the higher yield, it can be exported.
The
main reasons for low yield are:
- · The vast amount of cropped area (around 41%) is still unirrigated.
- · Shortage of electricity and other resources for irrigation.
- · Distortions of various emerging policies and leakages do not transfer benefit to real beneficiary of these policies.
- · Lack of skills for using high technology based irrigation.
- Yield can be improved by following ways:
- · Rationalization of subsidies and direct transfer to beneficiaries would benefit public investment.
- · There is need of research, education, extension, irrigation, water management, soil testing, water housing and cold storage to improve yields.
·
Land
collectivization irrigation not implemented on
large scale as in India 82.5% farmers have land holdings below 1 hectare (for
each farmer) which comprise only 10% of total land while 10% of farmers have
land holdings above 10 hectares (for each farmer) which comprise of 84% of land
which directly impact on productivity. If land collectivisation done on large
scale (like China implemented successfully) it can substantially increase
production. Though it is politically challenged but it will enhance
productivity dramatically.
Chapter 4: The Growth Fiscal Policy
Challenge
The
economic survey points out the need to increase public investment to revive
growth but without much fiscal largesse. Expenditure control and expenditure
switching, from savings to investment, shall be vital. A three pronged strategy
has been suggested going forward-
·
The country
would need to meet its medium term target of three percent of GDP with regards
to the fiscal deficit. Also going forward the government would need to reduce
or eliminate revenue deficit and ensure that borrowing, if any, is only for
productive purpose i.e. capital formation.
·
The above aim
can be achieved only through expenditure control and increasing the tax-GDP
ratio. Implementation of the Goods and Services Tax (GST) shall play a crucial
role in this regard.
·
However, as the
survey suggests the need for fiscal consolidation in the upcoming year should
not undermine the need for public investment.
Growth, Private and Public
Investment
The
primary engine of growth for the country would have to be the investment done
by the private sector. The public private partnership (PPP) can only act as a
facilitator or catalyst in the process. But currently domestic companies are
suffering from what the Mid-Year Economic Analysis 2014-15 called “balance
sheet syndrome with Indian characteristics”.
The
following causes can be attributed to this syndrome-
·
Flow Challenge
- Weak profitability and the debt burden have contributed to a diminished
appetite for investment among the private sector. The interest coverage ratio –
a measure that states how well a company’s debt obligations are covered by its
cash flows, a value of less than one would indicate the insufficiency of
earnings to cover interest payment- among domestic companies has been showing a
worsening trend. Also the debt equity ratio of the top 500 non-financial firms
in India is also quite high as compared to other BRICS nations and emerging
economies. (Approx. Russia-0.5,China 0.7, India-0.82)
·
Stock
Challenge – A weak institutional
framework to deal with bankruptcy has aggravated the difficulty – of- exit
challenge for over-indebted firms thus leading to the problem of stalled
projects.
·
Institutional Challenge- PPP (Public Private Partnership) model in
infrastructure has to be overhauled going forward in order for it to be viable.
This mode is mostly used for constructing roads. Currently the projects operate
on a number of models including Build-Operate-Transfer (BOT), Build-Lease-and-Transfer
(BLT), Build-Own-Operate-and-Transfer (BOOT) et al. The qualifying process for
the same needs to be fine-tuned as currently the tenders do not even specify
what the net worth of a bidder should be for a certain project. This inevitably
leads to the problem of stalled projects as mentioned before.
·
Financing Challenge- The majority of lending to infrastructure projects
has been by public sector banks and as a consequence their balance sheet
quality has deteriorated. An increase in NPAs diminishes the lending capacity
of banks. This issue would need to be tackled urgently along with the parallel
needs of conforming to Basel III norms.
Physical
connectivity (rural roads and railways) needs to keep pace with the surging
financial and digital connectivity in the country. Further investment in Indian
Railways can contribute to the growth of manufacturing, since it is a more
energy and cost efficient substitute to road transportation (logistics). For
this very purpose, as was indicated in the recent budget, tax free bond sales
to individuals for rail projects shall be allowed from April 1,2015.
Recently
the railways also got funds from the World Bank for development purposes. Recently
an MOU was signed between LIC and the railways, whereby it will receive funding
to the tune of ₹150,000 Cr over a period of five years for various
projects. This shall also help LIC’s purpose as they only park around 25 percent
of their annual premiums (Approx. ₹200,000 Cr) collections in equity, the rest go into
risk free instruments.
Chapter 5: Make in India
“Make
in India” refers to the rise of transformational sector. It can be in
registered manufacturing or service. So assessing transformational sector can
be done based on these five characteristics:
·
High levels of productivity, so
that incomes can increase;
·
Rapid rate of growth of
productivity in relation to the world frontier (international convergence) as
well as rapid growth toward the national frontier (domestic convergence);
·
A strong ability of the dynamic
sector to attract resources, thereby spreading the benefits to the rest of the
economy;
·
Alignment of the dynamic sector
with a country’s underlying resources, which typically tends to be unskilled
labour;
·
Tradability of the sector,
because that determines whether the sector can expand without running into
demand constraints, a feature that is important for large countries like India.
If we
look at the transformational properties of several sectors, here is what we can
conclude
Figure
5.1:
Source: Economic Survey
2014-15
When
we consider manufacturing as transformational sector, it should have some
prerequisites which a registered or formal manufacturing has; like high
productivity and rapid growth in productivity. Unregistered manufacturing
cannot be a transformational sector. Thus, efforts to encourage formalization
will be critical.
Sectors
such as telecommunications and finance though being highly productive and
dynamic fail to attract large amounts of unskilled labour, limiting the
benefits of the underlying dynamism. In other words, the dynamic sectors have
tended to be skill intensive sectors in which India does not necessarily have comparative
advantage. Though there is an exception here. Construction section is both
unskilled labour intensive and dynamic. But it is not a tradable sector, which
also limits its potential as a transformational sector.
So
the conditions for labour-intensive manufacturing need to be complemented with
rapid skill up gradation otherwise even these dynamic sectors may become
uncompetitive.
Means for Make in India
They
can be placed in three categories in decreasing order of effectiveness and
increasing order of controversy.
1. Improving
the business environment by making regulations and taxes less onerous, building
infrastructure, reforming labour laws, and enabling connectivity– all these
would reduce the cost of doing business, increase profitability, and hence
encourage the private sector, both domestic and foreign, to increase
investments.
2. Industrial
policy would target the promotion of manufacturing in particular: providing
subsidies, lowering the cost of capital, and creating special economic zones
(SEZs) for some or all manufacturing activity in particular.
3. Protectionist
would focus on the tradability of manufacturing, and hence consist of actions
to: shield domestic manufacturing from foreign competition via tariffs and
local content requirements; and provide export-related incentives.
Chapter 6: The Trade Challenge
Rapid
and sustained rates of growth are associated with rapid rates of export growth.
Ostry et. al. (2006) show, sustained growth spurts are almost always associated
with an average rise in manufacturing exports to GDP ratios over their growth
episodes of about 36 percentage points.
We
can see in the figure that during India’s rapid growth phase between 2002-03
and 2008-09, the ratio of exports of services to GDP increased dramatically,
from 4.0 per cent to nearly
9.0
per cent. Service exports grew at higher rate than manufacturing. But after
global financial crisis, manufacturing exports took lead from service exports.
However, both have slowed down in the last five years.
Figure 6.1:
Source:
Economic Survey 2014-15
Every
1 percent growth in world GDP was associated with a 3 percent growth in Indian
exports of services in 2001, which rose to over 8 percent a few years later,
stabilizing at around 5 just prior to the financial crisis.
Combining
the two charts, for India we can say that the external trading environment is
encountering two sets of headwinds: first, a slowdown in world growth which
will reduce Indian exports; and second, for any given world growth, export
growth will be even lower because of trade’s declining responsiveness.
Figure
6.2:
Source: Economic Survey 2014-15
There are several domestic factors that are contributing to the slowdown
of export growth such as weak infrastructure and challenging labour laws in the
case of manufacturing, and rising wages, scarcity of skilled labour in the case
of services and rapidly changing policy environment.
After the efforts of new government, the Indian economy will encounter
that the international trade landscape is substantially changing in three
significant ways.
First, to enter in global value-added chains based on
fragmenting/unbundling successive stages of production and locating them at
lowest cost destinations. India has been slowly integrating into these chains,
but at lower levels than most other dynamic Asian economies.
Second, negotiations on mega-regional agreements have been seriously
initiated.
Mega-regional agreements
Mega-regionals are deep integration partnerships between countries or
regions with a major share of world trade and foreign direct investment (FDI).
Beyond simply increasing trade links, the deals aim to improve regulatory
compatibility and provide a rules-based framework for ironing out differences
in investment and business climates.
The two most significant mega-regional trade agreements currently under
discussion are the Trans-Pacific Partnership (TPP) and
the Transatlantic Trade and Investment Partnership (TTIP). Both would
affect at least a quarter of world trade in goods and services (TPP: 26.3%;
TTIP: 43.6%) and of global FDI.
Trans-Pacific Partnership (TPP)
Originally a four-way free trade
agreement between Brunei, Chile, New Zealand and Singapore, the TPP now
encompasses eight additional countries: the US, Australia, Canada, Japan,
Malaysia, Mexico, Peru and Vietnam. South Korea might also join the group.
The TPP aims to achieve
extensive liberalization of both goods and services, and entails comprehensive
coverage of trade in services, investment, government procurement, non-tariff
measures and many regulatory topics.
Transatlantic Trade and
Investment Partnership (TTIP)
The TTIP negotiations, launched
in June 2013, aim for a far-reaching trade agreement between the US and the EU.
The goal is to remove trade
barriers as well as alignment, compatibility and possible harmonization of
regulations and standards governing the goods, services, investment and public
procurement markets. Research estimates that it could boost the
EU economy by €120 billion and the US economy by €90 billion annually.
Who is involved?
Figure 6.3:
And third,
China in response to domestic imperatives of re-balancing economy may go for
major liberalization of its economy.
China is now at
the centre of the Regional Comprehensive Economic partnership (RCEP) which
includes India, the Association of South East Asian Nations (ASEAN) countries,
as well as Japan, Korea, Australia and New Zealand.
Now, India has
two choices: measured integration (the status quo and/or RCEP) or ambitious
integration (via the TPP).
Measured integration would involve a slow but steady
pace of domestic reform dictated by India’s political constraints and capacity
which could only sustain regional agreements of the kind India has negotiated
with Asian partners.
The risk in the
status quo scenario is one of India being excluded from large integrated
markets with reduced trading possibilities. In the context of the slowdown in
both world growth and India’s export buoyancy, any possible exclusion from the
mega-regionals would be additionally worrisome.
Ambitious integration would essentially mean India
joining, or rather seeking to join, at some future date the TPP. Substantive
liberalization obligations under any future TPP will be greater than those
under India’s current Free Trade Agreements (FTAs) and probably ahead of
India’s planned pace of domestic reform. A significant upgrading of Indian
trade capability will be necessary for India to be able to join these mega-regional
trades.
About
the Author
This report has been
authored by Kapil Khatri, Monil Shah, Sangram Dhal, Tarun Vasnani and Virali
Shah. All of them are pursuing MBA from Institute of Management, Nirma
University, Ahmedabad, Gujarat, India.
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The information in this document has been printed
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